What is cash flow management and why is it important?

Many e-commerce businesses are concerned with maximizing profit but often ignore the need to maintain adequate cash flow. It is important to realize that even after you make a sale with a profit that far exceeds what you spent, it isn’t really considered a profit unless you have the money in hand, at your disposal. In other words, successfully running a business requires a well-maintained flow of cash.

Money matters

Frequent cash shortages are a sign of poor cash flow management. Money is what keeps your business running, covering costs of supply, production, procurement, and so much more. When you’re unable to keep track of your cash inflow and outflow, let alone sustain it on a daily basis, your business can suffer. This is why you need effective cash flow management: to minimize the risk of failure.

In this lesson, we’ll be covering the importance of cash flow management and some tips that can help you better manage your cash. First, let’s start with a basic question.

What is the difference between profit and cash flow?

The key difference between profit and cash flow lies in the timing. While your business may look profitable on paper in the long term, you need to check whether you’re able to meet your financial obligations and pay off debts in the short term. This is the true measure of good cash flow management.

In addition to assessing profit or loss, you need to sharply focus on what drives the cash into your business. This relies heavily on your ability to collect receivables on time and the availability of funding.

What is cash flow management?

At its very core, cash flow management is about delaying cash outflow as much as possible and encouraging your debtors to pay you as quickly as possible.

Cash flow management basics

Let’s start with the basics. Cash flow is the movement of cash funds in and out of your business during a certain period of time. Cash flow management refers to keeping track of your cash outflow and inflow on a regular basis, be it daily, weekly, monthly, or quarterly. This is important in order to meet the day-to-day requirements of running the business and other short-term financial obligations.

Positive cash flow

When the cash funds flowing into your business (from sales, receivables, etc) exceed the money that’s moving out, (in the form of expenses, salaries, etc.) your business has a positive cash flow.

Negative cash flow

When the outflow of cash or the obligations is far higher than the incoming funds, this is referred to as negative cash flow. Needless to say, this can be devastating for the business. Good cash flow management is all about maintaining positive cash flow and preventing negative cash flow.

Maintaining a positive cash flow is easier said than done. You need to carry out detailed cash flow analyses, prepare cash flow statements, and assess your business’s state of affairs. This will entail decisions and strategies such as cutting expenses, increasing funds, boosting sales, and applying for credit or loans.

Cash flow and business growth

Growing your business requires a great deal of investment, from setting up shop, opening new stores, and marketing to drive sales. All of these activities require you to have the cash up front. This is why smart cash flow management is also crucial to making actual profit. 

Remember, any small business has costs and obligations such as paying employees, production or procurement, delivery charges, and more. As you already know, this puts a huge strain on your cash outflow. You need to have a surplus that remains after clearing expenses to deem your business profitable.

Why cash flow management is important

Small businesses such as online e-commerce stores need to stay on top of their cash flow so that they can avoid extensive cash shortages, which can damage the business. A cash shortage is a gap between cash inflow and outflow. It is quite obvious that you can’t maintain a business if you’re unable to pay your bills on time.

Predict shortages and prepare

When you keep track of your day-to-day cash flow, you’re much more able to predict shortages beforehand. This means you will be well-prepared for it by the time it occurs. For instance, you might know when it is time to collect outstanding money or run a promotional drive to boost sales. This takes away a great deal of stress and makes sure you’re better equipped to deal with it.

Save and spend

Smart cash flow management also gives you a better idea of how much money you have. This way you’ll know how much you have to save on priority in emergency funds and how much you can invest into the growth development of your online business.

Gain trust and confidence

A well-kept cash flow statement also gains trust from banks, lenders and product suppliers. It keeps your financiers and investors informed on when and how you plan to pay them back. When you’re more forthcoming, they’ll be more willing to work with you and back you up when times get tough for your business.

Tips to improve cash flow

Plan in advance

Many assume that growing your business can solve the cash flow problem. On the contrary, the bigger your business grows, the more exaggerated your cash flow problems become. This is why you need to plan for growth and cash flow in advance.

Tighten credit requirements

Extending credit to customers might boost the rate of sales in the long term but could also affect your business in the short term. This in turn can stall day-to-day management. The best thing you can do is be selective about who you offer goods on credit to. Thoroughly research your clientele to verify their credit worthiness. Make sure they have a history of reliably paying off debts on time.

Boost sales

This might seem like a no-brainer. In order to maintain a positive cash flow, you need to scale up your promotional activities and increase sales, either by attracting new customers or selling more goods and services to existing customers.

New customer acquisition isn’t as easy as selling more of your products to existing customers, especially when you’re just starting out. Knowing your audience and your customer is key here. Use payment software and online selling platforms that give you access to customer habits and patterns, which you can use to plan further marketing activities.

In other words, you can sell better once you know why your customers are buying from you in the first place.

Special discounts for loyal accounts

Offering special discounts and offers to customers who pay on time or early is a great incentive that motivates your clientele to be prompt in paying your bills. Your profit margin might take a slight hit but that can still be offset by the ready cash in hand you’re receiving. Just think: Would it be better to have $20 in hand right now or $25 in a couple of weeks, especially when you have suppliers to pay today?

It also encourages your customers to repeatedly buy from your store because you offer better deals. In short, offering a discount for prompt payment is a smart way to drive sales higher.

Track your cash flow situation regularly

A monthly assessment of your cash flow can help you keep track of whether you’re generating the type of funds your business needs to sustain itself. This can also make you better at projecting future cash flows and ways to take care of outstanding bills.

Cash flow projection

Preparing well-informed cash flow projections for the coming month, quarter and even year can keep you alert on potential areas where your business needs to focus. It is a two-part process.

  1. Assess how much cash your business has in hand at the moment. Next, estimate how much money will be coming into the business from customers, outstanding receivable accounts such as service charges, partial collections of defaulting debts, and other sources. You need to have a rough estimate of when this cash inflow will be arriving as well.
  1. Assess your cash outflow for the upcoming time period, be it a week, a month, or a quarter. Keep track of what you will be spending on such as utilities, equipment,  rent, employee salaries, inventory, storage, maintenance and other expenses.

Carrying out these two important assessments will give you a great idea of how well your business can manage its incoming cash flows to meet upcoming cash outlays. Based on this, you can create accurate cash flow projections.

Speeding up receivables

The best way to improve cash flow is to encourage your debtors, customers, and other defaulting accounts to pay on time. This can be achieved by offering incentives such as discounts for promptly paying customers, requesting deposit payments, establishing creditworthiness, and getting rid of outdated inventory. You also should issue invoices as soon as you make a sale and follow up on customers when there’s a delay in payment. Having a cash-on-delivery policy is highly important for online customers that tend to default.

Smart Management of payables

  • Take advantage of payment periods. There’s no reason why you should make payment for a product within 15 days if the due date is in 30 days. You’ll be able to retain funds for longer and focus on other, high-priority expenses that are imminent. 
  • Communicate with your supplier consistently. Let them know in advance if you need to request an extension.
  • When you’re choosing suppliers, consider vendors that offer flexible payment terms, even if they cost slightly more. It’s a better option if you’re prone to delays in repayment.

Dealing with sudden shortages

A cash flow shortage is something that any business owner may have to deal with from time to time. It is an inevitable reality for most startups, especially if you’re running an online business.

The best way to overcome a shortage is to detect it early. Regular cash flow projections based on the past can help you foresee a shortage way before it happens. To offset the deficit, you can borrow a long-term loan from an institution or from suppliers you have a good history with, so that when it does happen, you’ll be prepared. It will also give you enough time to plan your debt repayment strategy. Suppliers are also more likely to give you favorable terms if you’ve been a loyal customer. The crucial point to note here is to spot the shortfall as early as possible.

Getting customers to pay faster

Sometimes you might have to be persistent with certain customers. Depending on the emergency,  you might also have to allow for a slight discount, just to motivate defaulting customers. 

Some of your worst defaulters might be willing to pay if you offer them a steeper discount for immediate payment. You can always choose to not do business with them in the future if your experience has been difficult. However, when it comes to collecting payment, some cash flow is better than none at all, especially when you’re hard-pressed to meet your own expenses.

Selling and leasing

Another way to raise funds is selling some of the assets that you can do without for a while or leasing office equipment such as computers, printers, furniture, etc. There are plenty of leasing companies who would undertake it on your behalf.

Prioritize spending

Sort out which bills you need to pay first. Make sure you pay your employees on time–that’s super urgent. Suppliers are next on the list. Petty, one-time expenses come last. You can also make partial payments and ask for an extension for others if they are willing. Remember, always prioritize the people you regularly do business with and the most valuable people to your company.

Shorten the conversion period

Look for ways to speed up cash flow conversion. Remember, a high rate of inventory turnover (sales) doesn’t mean much if your customers don’t pay up on time. Don’t get distracted by long-term gains and sacrifice the imminent health of your business.

Bottom line

So far we’ve covered the advantages of good cash flow management and the various ways it can help your business grow. From the next lesson onwards, we’ll be looking at the cash flow statement on a deeper level.

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