Main Aim of Cash Flow Management
In simple terms, cash flow management is the tracking and controlling of how much funds come in and out of a business to forecast cash flow needs. Cash flow management is the process of daily monitoring the net amount of cash receipts, less the expenses.
Effective cash flow management strategies are important because they aid in predicting how much funds will be available to cover debt, payroll, settle invoices, and such.
3 Components of Cash Flow Management
There are three components from which cash can flow to and from:
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- Cash Flow from Operations (CFO):
CFO refers to cash generated by a company’s regular business activities. This serves as an indicator to assess if the company is maintaining sufficient funds from its core operations to meet financial obligations and cover daily expenses such as operation costs and salaries. Positive CFO is vital for business continuity as it allows for reinvestment in operations, debt settlement, dividend payments, and business development opportunities.
To reach financial sustainability in the long-term, the company must have more CFO inflows from operations than outgoing cash.
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- Cash Flow from Investing (CFI):
CFI is a financial metric measuring the amount of cash a company generated or spent from investment-related activities within a specified time frame, such as, acquisition or disposal of long-term assets including property, equipment, investments, and loans.
Positive CFI suggested that the company has gained cash from the investment activity, for example selling assets at a profit. Negative CFI indicates that the company has invested more cash than it earned from the investing activity, such as investment in the expansion of its operations.
While positive CFI is favorable, negative CFI may be justified especially when the company is strategically investing in future growth, improved profitability, and continuity.
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- Cash Flow from Financing (CFF):
CFF represents the net flows of cash used to fund the business’ operations and working capital. Such activities may include issuing debt (bonds or loans), equity (issuing stocks), and distributing dividends amongst shareholders.
CFF is a critical element of the statement of cash flows, as it reflects how the company raises and deploys its capital to meet financial obligations and support its growth objectives. Through CFF, investors can gain insight into the financial health of the company and its capacity to manage capital structure.
AP & Cash Flow Management
Accounts payable is a focal component of managing cash flow as it represents the money a company owes vendors and suppliers. Time management plays an important role here, as once liabilities are due, managing the timing of the payments helps a business maintain a healthy cash flow.
If a company is experiencing a cash flow shortage, they may delay accounts payable to conserve cash. However, this action risks damaging vendor relationships and negatively impact credit ratings, apart from incurring late fees and interest charges. On the other hand, paying liabilities too quickly may negatively impact cash flow since the amount of cash on hand will be rapidly reduced. This signifies the importance of proper cash flow management.
Striking a balance between delaying transactions and paying on time is the key to effective cash management. There are various strategies available for balancing cash flows, such as negotiating payment terms or implementing an e-invoicing system.
4 Ways to Effectively Manage Cash Flow
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- Efficient accounts receivable collection process (mobilizing and managing cash flow):
Similar to accounts payable management, accounts receivable must be managed in a timely manner, as delays in receivables may cause strain on business operations.
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- Taking advantage of payment terms (maintaining relations):
Paying vendors early is not the key to balancing liabilities. Taking money out of the company’s accounts before bills are due increases the probability of cash flows issues. Taking advantage of payment terms can aid in cash longevity, hence preventing cash flow issues while waiting for accounts payable to settle liabilities.
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- Keeping operating expenses under control (forecasting):
Regulating operating costs is as important as balancing accounts payable. One such way to implement this is to be mindful of the costs insurance, utilities, payroll services, and salaries are incurring.
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- Having a plan for excess cash (investing surplus):
Effective cash management is about increasing the amount of money flowing into a business and minimizing the amount of money going out. however, there is more than this. Should the company have excess funds, they may be directed towards tax payments, investing in equipment, business development, and other ventures. It is of key importance to identify whether the excess cash will be beneficial in the short- or long-term.
Improving Cash Flow
All companies may experience cash flow problems, irrespective of size and profit generated. This usually happens when debts are due prior to collecting sufficient funds from accounts receivable to cover bills.
To gain control of cash flow, one might consider implementing new policies, such as offering discounts to receivable who pay early, forming B2B buying cooperatives, and using e-payments for bill payments. Additionally, better payment terms may be negotiated with vendors, exploring the possibility of improving invoicing procedures, and even considering increasing the price of the product or service to create an influx in cash flow.
Monitoring Cash Flow
A cash flow statement is the most effective way to monitor cash flow. The statement provides an overview of the money that came into and out of the business to understand the cash position on a monthly basis.
The statement is split into three parts: CFO, CFI, CFF. From each part, cash transactions are identified, and the outgoings are deducted from the incoming cash flow, resulting in the net cash flow.
The main use of a cash flow statement is to:
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- Track where money is coming in from;
- Understand where the company spends the most money;
- Provide a cash reality rather than abstract accounting;
- Spot cash inconsistencies or shortages to plan for future cash flows.