It doesn’t matter if your business is a local start-up or a multi-national giant, when it comes to the management of your cash flow and your profit, you share the same concerns.
It is vital to understand the difference between cash flow and profits, as well as that they don’t necessarily coincide. It may seem counter-intuitive but the reality is that perfectly profitable businesses do go out of business because of cash flow problems
Profit is the gain you accrue from the difference between sales and costs within a specified period over maybe a month or a year. However, sales may be made, goods may have been delivered but the payment may well be deferred, perhaps as a result of giving credit to customers. While you wait for that money to come in, you still have to rely on your cash flow to meet your obligations to suppliers and employees, and many others.
It’s often easier for a business to report the profits on paper than to have the cash in hand to pay the short-term bills. This can have serious consequences such as hampering your business growth and even leading to the complete failing of your business.
Business owners must carefully manage growth phases and ensure they don’t lead to cash shortages. Expansion demands extra money, and it is easy to get over your head as you are driven by your enthusiasm to grow and take advantage of new opportunities.
It’s not good enough to know that you’ll have the money to pay the bills next month if you have creditors demanding payment now. Cash flow is your ability to meet your payments in the moment of demand, not at some future date. Not being able to do this, can crash your business.
Sound overall financial management and the regulation of cash flow in particular, will reduce your vulnerability to serious disruption of your business. You need a cash flow management strategy that focuses on improving cash flow and using a tried and tested method of cash flow forecast to predict and manage slow periods.
Some best cash flow management practices include:
- Developing policies and procedures to ensure that you give credit only to reliable and profitable customers while reducing the average days outstanding by debtors by specifying payment terms and charging interest on outstanding accounts;
- Keeping your books up to date so that you can rely on your cash flow forecast;
- Having contingency plans in place to borrow money at short notice for unexpected crises in cash flow. Rather be prepared than to have to, at short notice, negotiate access to finance on unfavourable terms;
- Managing your bill payment schedule so that you can optimise on discounts but otherwise don’t pay early; and equally don’t pay late and compromise your relationships with suppliers;
- Adequately funding your business ensuring that any outlay of capital expenditure is matched by long-term funding so that cash outlays coincide with cash inflows;
- Keeping inventory to the necessary minimum so that you have less money tied up in stock and more cash available to the business
- Forecasting so that you plan as well as possible for the ups and downs of cash flow
The bottom-line is not just profits. It also includes the constant planning and monitoring of your cash flow so that you always have enough available funds to meet your costs on time.
Keep in mind that profit and cash flow do not necessarily go hand-in-hand. More businesses sink because of cash flow issues rather than the lack of profit. This is a good reason to place your priority attention on your cash flow, and not just the prize of profits.