Managing your cash flow is critical to helping avoid the extended cash shortages that can be caused by large gaps in your cash inflows and outflows. But it’s a task that many business leaders have difficulty doing, especially in an uncertain economy.
To gain a better handle on your cash flow, consider establishing a proactive funds management process, which may help you avoid the cash shortages that can damage your business or even cause its demise.
“The greatest risk you face is not having the funds to pay your employees and vendors,” says Jane Zalla, treasury management sales officer with Fifth Third Bank.
Smart Business spoke with Zalla about how proactive funds management can help maximize your company’s cash flow and make sure you’re getting the most impact from your cash flow.
How has the economy affected funds management?
A lot of industries are experiencing problems, causing a trickledown effect into other industries. If your vendor or customer base is heavily based in an industry that is experiencing problems, you might run into cash flow problems.
Credit is also a big concern. A lot of companies rely on credit from banks to manage their cash flow and use it as working capital. But the credit standards and restrictions have tightened, making it more difficult to obtain the credit you need to make up for your cash shortages.
How can you help improve your company’s profitability through proactive funds management?
Regularly perform a cash flow analysis and develop a financial forecast. One suggestion is to have a rolling 13-week cash flow forecast, because although it is difficult to predict the future, with proper forecasting and planning, one can help overcome unforeseen disruptions. Even if you’re not directly impacted by something, your vendors and clients could be, and that, in turn, may have an adverse effect on your cash cycle.
One way to protect your company from cash flow shortages is to create a cash reserve. Organizations should typically have a 30-day reserve to cover normal operating expenses. This improves your ability to fund your own business operations instead of having to request credit from a bank.
Another strategy is to shorten your cash flow conversion period. Send invoices out promptly — as soon as the goods or services are delivered — to aid in collecting payment more quickly. You might also consider offering discounts for prompt payment.
Monitor past due accounts and notify customers when bills are late. Consider establishing a deposit policy, in which a portion is paid upfront before goods are provided and the rest is paid after delivery to help improve your receivables process.
How do you begin doing a cash flow analysis?
First, look at what you’re producing and selling and the costs associated with this. You have to look at your overall business structure, such as how many employees you have to pay, what type of operating facility you have and what the overall expenses are for running your business, from cost of goods sold to delivery.
You also have to look at how long it takes to receive payment on your goods. The goal should be to have this as short as possible. The faster you can get money into your account, the faster your cash flow starts working for you and you can consider either investing overnight or paying down debt. Depending on your business, a typical receivables time frame is 30 days outstanding; however, this will vary depending on the industry and other factors.
Managing the receivables process is critical in forecasting your cash flow. Sending out invoices promptly and managing the collection process will help minimize the gap between the cash inflows and outflows.
The payables process is also important for cash flow. Typically, the goal is to extend out as much as possible while keeping within the agreements of your vendors. Extending your payables allows you to keep the money in your account longer, earning interest and/or possibly paying down debt and saving on the interest expense.
How can you ensure you’re getting more impact from your company’s cash flow?
Having strong cash flow is critical, and it’s always good practice to build up cash reserves for times when cash flow may become an issue. While you’re doing this, you can consider placing the idle balances in short-term options to earn higher interest. Your cash reserves should be liquid to allow for easy access, but you don’t want it just sitting there doing nothing.
It’s always good practice to review options with your banker and consider such items as sweeps or paying down debt, which can be a huge expense that hits your bottom line. You can save the interest expense on the credit side if you pay this down quickly.
Having a positive cash flow also allows you to fund your own endeavors. You can expand, purchase new equipment or facilities, acquire smaller businesses or buy out partners on your own if you have a strong cash flow.
What are the benefits of proactive funds management?
You may earn more income if you manage your funds and cash flow. You get paid on the sales from the goods you produce but have to make sure what you’re selling pays for your expenses.
If you manage your cash flow, you are more likely to have money set aside to earn a higher interest rate or to use to pay down debt. Managing your expenses and cash flow will help put you in a more positive financial position.
Jane Zalla is treasury management sales officer with Fifth Third Bank. Reach her at (513) 534-0245 or email@example.com.