Cash Flow Management: The Ultimate Guide to Financing Businesses

The main purpose of cash flow management is to make sure that there are sufficient funds available from both sources at all times so that businesses can continue operating smoothly and efficiently without having any financial problems such as being unable to pay employees on time or making late payments for suppliers' invoices.

A well-managed cash flow helps prevent overspending and helps ensure you have enough money coming in so that you can make timely debt payments. It also alerts you when there are problems with your financial operations so that you can take action before things get worse.

When talking about the big three of cash management people are referring to:

• Accounts receivable
• Accounts payable
• Inventory

These three things work hand in hand to deliver a cash flow that runs the business every day. Without effective cash management, a business risks failure in both the short and long term.

A three-way forecast, or 3 financial statements is a financial model combining three key reports into one consolidated forecast:

• Profit & Loss (income statement)
• Balance sheet
• Cashflow Statement

Also known as statutory accounts, financial statements are legally required to be produced annually by businesses. So you can forecast your future cash position and financial health.

At the start of 2022, there were estimated to be 5.47 million small businesses (with 0 to 49 employees) or 99.2% of the total business population (source: gov.uk.). However, SMEs live and die by their operating cash flow.

A Xero Small Business Insights (XSBI)'s report entitled Crunch: Cash flow challenges facing small businesses published in July 2022 found that more than 9 in 10 small businesses experience at least one month of negative cash flow each year. Furthermore, one in four businesses in the United Kingdom is experiencing more intense cash flow stress, being cash flow negative more than six months each year.

Rates of cash flow crunches varied significantly by key industries, both before and during the COVID-19 pandemic. In 2019, UK small businesses in the professional services industry were less likely to be cash flow negative in a given month (38%) compared to those in the retail and hospitality industries (45% and 44% respectively).

Many entrepreneurs face cash flow issues during the startup phase of their businesses. This is especially true for those who are first starting out and don't have any prior experience with managing money.Here are some common issues that may cause cash flow problems:

• Poor accounting / budgeting practices
• Under-capitalization
• Inaccurate forecasting
• Inadequate payment systems
• Inventory Management

So how do you go about innovating or improving your process? You can use these 5 steps:

1. Track Everything - start with tracking key metrics related to your business such as revenue and expenses.
2. Set Targets - what are you trying to achieve? What would success look like? What is a good number of sales compared to other businesses in your industry?
3. Decide on Key Performance Indicators (KPI's)- what are the indicators that will help you reach your targets? These are the metrics that will drive your success.
4. Develop Your Own Models- models help you put everything together and make it understandable for everyone involved in the decision-making process at every level of your organization.
5. Communicate Sustainably- communication is key! This involves communicating long term goals and targets as well as developing effective internal and external communications channels so that everybody knows what's going.

Your second step is determining what type of cash flow management process is best for your business. There are several different methods that can be used:

• Straight line amortization: This method uses straight line amortization over the life of the asset to determine its value at any given time. It's commonly used when accounting for assets such as equipment, machinery and buildings because it allows you to easily calculate depreciation amounts over time.
• Declining balance depreciation: This method uses a declining balance formula over a specified period of time to determine depreciation expenses on an annual basis. It generally results in lower tax liabilities than straight line amortization and is most commonly used with shorter term assets (usually less than five years).
• Sum of years' digits depreciation: This method uses the sum of all digits in a number (1+2+3+4+5=15) times an assigned percentage rate to determine the annual depreciation expense on an asset.
• Lump sum depreciation: Lump sum depreciation is based on the value of an asset at the time of purchase. You may opt for this method if you don't want to account for depreciation over time or if your business has just purchased a new piece of equipment.

A key component of a top-notch cash flow management process is forecasting. When it comes to forecasting revenue, there are two main approaches: bottom-up and top-down.

• Bottom-up forecasting involves looking at individual products or services offered by a company and estimating what each one may bring in over time based on historical data and current trends in the industry.
• Top-down forecasting works by looking at macroeconomic factors such as GDP growth rates or interest rates and then applying those numbers to individual products or services offered by a company.

The two main components of cash flow management are forecasting and control. The following are some of the key areas that should be considered when implementing a powerful and seamless cash flow management process:

• Data-driven solutions
• Accounts payable automation
• Automated payments
• Cash flow forecasting software
• Budgeting software
• Validation workflows