Cash is at the heart of every business.
To survive and grow, a business must generate enough cash, on an ongoing basis, to pay customers, employees, bills and expenses – in other words, to keep the lights on!
The theory is simple – make sure that more cash comes into the business than goes out. In reality, the challenge is much more difficult.
But first, what is cash flow and why is it so important?
What is cash flow?
Cash flow refers to the amount of cash coming in and out of a business over a period of time. In a standard business model, cash generally “flows in” from sales/revenues, investments or asset sales. While cash usually “flows out” for the purposes of expenses, disbursements and purchases.
Understanding where cash shortages or surpluses are likely to occur enables management to anticipate and take proactive steps to manage potential cash issues before they arise. This might include identifying the right opportunities to invest capital, pay off existing debts or negotiate extended terms with creditors or debtors.
For more details on the implications that cash flow issues can have for a business, check out our recent article on the benefits of planning and predicting cash flow through the use of budgets and forecasts.
Managing cash flow
A simple formula, while useful, will not solve your cash flow challenges.
Cash flow management requires a constant effort and robust finance processes and controls within a business. One thing that should remain constant? A business should always have an overview of its cash flow position and understand how much money is going in and out of the business during any given period. This is easier said than done!
In this article, however, we look specifically at the following 3 key elements for businesses to consider when dealing with cash flow:
- Accounts Receivable – Accounts receivable is the outstanding amount that a business is owed from customers and generally arises from a company selling goods or services on credit. For example, a payment may only become due 15 or 30 days after the service or goods have been delivered.
- Inventories – Commonly known as stocks, these are the goods or materials that a business has purchased and is holding in the business with the ultimate goal of reselling them for a profit.
- Accounts Payable – Accounts payable is money owed by a business to its suppliers or vendors. For example, where services or goods have been delivered but have not yet been paid for. It is usually shown as a liability on a company’s balance sheet.
So how can a business maintain control over these three functions?
We have outlined below just a few tips that can help a business manage cash flow in these areas!
1. Accounts Receivable
Imagine not having any accounts receivable! A world where clients pay for all goods and services at the same time as their purchase, delivery or service completion.
This is not, however, the reality of how business works – particularly in the world of SMEs!
Why not? It is already custom and practice for businesses across various industries and across the world to offer and receive payment terms. It will be very difficult to change the practice of an entire industry!
Also, in order to grow a client base, a business will usually have to provide credit terms to customers. These customers are, at the same time, trying to manage their own cash flow – particularly if they are a startup or SME. If you refuse, customers could very well move to a competitor who offers more reasonable payment terms. It is better to have customers paying late than not having any customers at all!
So, if avoiding credit terms is not an option, what can a business do to ensure it maintains proper controls over its receivables?
- Seek an advance or down payment when providing credit terms to customers. This is one way of reducing the amount of your receivables and also partially hedging against non-payment. Down-payments are a common mechanism used by businesses, particularly SMEs, in the Philippines. There is a limit to this, however, in that contracts involving down-payments will usually be reserved for larger projects or longer term engagement periods.
- Only provide credit terms that align with a client’s credit worthiness. Understand the ability of your clients to pay. If a client is constantly late with payment, do not consider extending credit terms unless they can prove their ability to consistently pay on time.
- Use technology and automate your accounts receivable function. Through the use of cloud accounting solutions, you can create a system that automatically alerts when invoices are to be issued, when payments fall due and when payments are delayed. Invoices can now be issued through these cloud accounting solutions! It also helps to identify which clients are notoriously late with payments as this information might then be added into a financial forecast or at least available for a management decision. Here’s how cloud accounting can save your business time and money!
- Implement controls and processes for your accounts receivable function. Can you reduce the level of sign-offs required to issue an invoice? Can you issue invoices in batches to reduce lead time? Is there a mechanism to restrict services or deliveries to clients who are late on payments (only applicable if the business can afford this luxury..)? For reference, here are some key financial controls that can help in the F&B industry.
What is the connection between inventories and cash flow? Quite simply, when you buy inventory, you pay for it and cash leaves the company. When you are holding inventory, the cash is tied up. You are not making any money from holding the inventory. You may also have to pay for increased storage costs (if you are holding too much inventory). When you finally sell the inventory, you receive cash.
So what’s the best way to control cash flow when it comes to inventory? Robust inventory management!
The key is making sure that you have enough inventory to meet sales demand but not so much that it results in higher storage costs or an increased possibility of wastage or spoilage.
Here are some practical tips for aligning your inventory management system with your finance function:
- Inter-department communication – Inventory management is an important technical skill which will generally be controlled by the supply chain team. However, it is important that the supply chain team is communicating with the finance department so that the company’s cashflow can be monitored and controlled. Good communication arises where key processes have been implemented and are followed.
- Point of Sales System – For retail businesses, an integrated Point of Sale system (POS) can really help a business manage its inventory levels, generate the necessary sales documentation and interface with the company’s accounting books. Best results are achieved here through the utilisation of cloud accounting systems and online accounting solutions such as Xero and Quickbooks online.
- Automate – If you are a manufacturing business, a POS will not be the optimum solution. However, there is a significant amount of inventory management solutions available in the market. We recently wrote about some of the existing cloud accounting solutions that can now also support inventory tracking for a business.
- Costing – The costing of inventories is an important consideration for businesses. There are a number of different mechanisms that businesses can use including FIFO, LIFO, Weighted Average and the Specific Identification Method. The key here is whichever one your business uses, make sure to use it on a consistent basis! Don’t switch between different costing methods as this will skew your data. Each of these costing methods are explained in our recent article on why inventory matters for retail in the Philippines.
3. Accounts Payable
Settling any amounts due and owing to suppliers and vendors at the earliest possible date is undoubtedly sound business practice. This helps avoid late payments, poor credit ratings and also helps to establish a solid reputation as a commercial client to deal with.
Again, however, this is not the reality of business! Your business may not always have the sufficient funds to be able to pay straight away. You are likely to have other vendors and suppliers to pay first!
So what can you do about it?
- Seek longer credit terms. Before requesting credit terms, you need to have a good reputation with the supplier. This can be developed by ensuring your business is prompt with its payments. The better the commercial relationship between supplier and client, the easier it will be to negotiate more beneficial payment terms.
- Standardize payment frequency – To maintain a more consistent oversight of your payables function, it can help to standardize the regularity of payments. For example, depending on the type of clients or vendors, the business could establish a system where it has just one or two scheduled payment dates per month. This reduces uncertainty on cash flow and provides management with a more informed overview on the cash position.
- Use technology and automate. Accounting solutions such as Xero and Quickbooks Online make it simple for business to manage their account payables. From generating payments, to alerts prior to penalties becoming due to vendor management, these kind of solutions help startups and SMEs manage their entire account payables function and ensures that all information is then integrated into the books of accounts. Check out our recent article on how Xero and Quickbooks Online can make a difference to the accounting function within your businesses.
CloudCfo supports clients with their cash flow management, including treasury management and weekly reconciliations! Contact our team at firstname.lastname@example.org if you are seeking support with your cash flow process!
We are experts at implementing processes for invoicing and collections. Depending on your business model, CloudCfo will customize the process for your company and industry. We implement processes for managing outstanding payments, developing accurate financial statements and anticipating business growth.
We also advise on inventory management and process optimization for ensuring cash flow is constantly monitored and controlled. We help clients integrate inventory management software solutions, online tools and platforms across the business.
As your outsourced accounting firm here in the Philippines, we implement processes and controls to ensure that your management team has full confidence in all payments and disbursements that leave the company.