Cash Flow Management: Steps, Principles and How-To (2024)

Following effective cash flow management practices is essential for businesses, as it ensures a steady flow of funds, enabling them to meet business expenses, service financial obligations, capitalise on growth opportunities, and navigate unforeseen challenges with greater ease.

What is cash flow management?

Cash flow management is the process of analysing, monitoring, and optimising the inflow and outflow of money from your business. It aims to accurately forecast your business’s cash flow needs by effectively tracking and controlling your cash inflows and outflows.

The primary sources of cash inflows include cash sales, payments from customers, interest on savings, bank loans, and shareholder investments. Similarly, cash outflows are in the form of raw material purchases, salary payments, rent expenses, taxes, and more.

Effective cash flow management ensures that cash inflows exceed cash outflows, empowering businesses to reinvest for higher growth while enjoying adequate liquidity.

Cash Flow Management: Steps, Principles and How-To (1)

What is the main aim of cash flow management?

As cash flow management entails meticulous tracking, analysis, and optimization of how much money is coming in and going out of business, it aims to strike a balance between short-term cash needs and long-term productivity. Being pivotal to achieving operational success and financial health, the main aim of cash flow management is to sustain adequate liquidity at the lowest cost.

Below, we outline the key objectives of cash flow management.

Better cash flow control: Cash flow management assists firms in limiting their cash outflows while encouraging the acceleration of cash inflows. This usually takes the form of a reduction in operational and tax expenses and shorter cash cycles, ensuring adequate liquidity management and solvency levels.

Ensure adequate cash reserves: Adopting successful cash flow management policies ensures that firms retain adequate flexibility to meet unforeseen circumstances, whether in the form of a fall in demand, supply chain disruptions, or the development of new technology, which can result in unexpected costs.

Pursue growth opportunities: Cash flow management done right enables companies to methodically plan asset purchases and business expansion. By undertaking cash flow forecasting and providing for expected capital expenditures, firms can ensure they stay on track with their scaling plans and additional financing requirements, if necessary.

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Optimise cash holdings: Organisations are better placed to understand when the excessive cash lying in their accounts is indeed idle if they undertake cash flow management processes. Accordingly, investments can be made in a heady mix of liquid and short-term funds that offer additional returns with quick liquidity.

Maintain regulatory compliance: Cash flow management systems assist businesses in the proper maintenance of accounts as they involve the creation of a cash budget and cash flow forecasting. This enables companies to prevent significant errors in recording cash receipts and disbursements, minimising the likelihood of maintaining erroneous financial accounts.

Support clear communication: Many firms rely on communicating with their external and internal stakeholders, especially department heads, through cash budgets and cash flow statements that are prepared during the cash flow management process. Such transparency in the detailing of forecasting assumptions helps build trust and ensures clear financial communication.

Ensure business continuity: Several profitable firms have had to shut down due to cash flow issues. By ensuring firms maintain optimal cash reserves, including for emergencies, cash flow management systems facilitate long-term business continuity.

What is an example of cash flow management?

Example 1: Adequate cash

Consider a manufacturing company that extends a 30-day payment policy to its customers and is liable to make good on its vendor payments in 60 days. In this case, the company follows healthy cash flow management policies as it has adequate time (twice) to process its receipts.

Example 2: Potential cash shortfall

Continuing the previous example, let us assume the company is due to make a payment of £200,000 in 30 days and comes across an investment opportunity requiring £200,000 immediately. In such a case, if the company doesn’t maintain cash buffers, it may either have to renegotiate its terms with the suppliers or opt for a loan to avoid exhausting its cash completely.

See also: Cash Flow: definition, calculation, principle, all you need to know!

How to manage cash flow: Process

Cash flow management consists of cash flow analysis, cash flow forecast and cash flow optimization. The simplest way for businesses to manage their cash flows is to create a cash flow statement(CFS). It can be drawn with the help of cash flow management software or an Excel sheet.

A CFS makes it easier to track all the cash inflows and outflows and preemptively highlights when a business runs the risk of running out of cash. So, what are the steps and four components of cash flow management?

  1. Make projections: The cash flow management process begins with an estimation of your revenues and expenses. These forecasts can be estimated from historical data, sales projections, and other relevant factors. Generally, projections are made for the coming four to six weeks, as the longer the duration, the more inaccurate the forecasts.

  2. Prepare cash flow statement: Follow up by plugging the forecasts into your cash flow statement. At this stage, you can also categorise cash flows into operating activities, investing activities, and financing activities for a holistic view. This is essential for tracking working capital needs where the highest requirement for streamlining lies due to a potential mismatch between inventory, receivables, and payables.

  3. Monitor cash flow: Regularly track, update, and compare actual cash flows to the projected figures. In case the statement projects any shortfalls, analyse the possible causes of variance, and the possible remedial action. It could also involve changes to your assumptions underlying the projections.

  4. Implement corrective strategies: Finally, optimise your company’s financial position by taking action to streamline all cash flow issues. Accelerating cash collection, reducing unnecessary expenses, renegotiating payment terms, investing the cash surplus in better products, and exploring financing options are some of the popular cash flow management strategies.

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Why is cash flow management important?

The significance of cash flow management lies in understanding why cash flow is important in management in the first place. Positive cash flows indicate that the firm is generating enough cash to meet its expenses, service its debt, and invest in growth opportunities.

On the other hand, even if a company is profitable, a negative cash flow would mar its chances of scaling its operations. Indeed, over 38% of startups in the UK fail because of cash crunches and failure to raise more funds.

Hence, following effective cash flow management practices is essential to meet the following objectives:

  • Improve liquidity management by weeding out unnecessary expenses and minimising operating costs.
  • Closely monitor cash spending, strategically plan their investments, and improve their resource allocation.
  • Meet their payables and debt obligations, strengthening financial discipline and stakeholder relationships and fostering credibility.
  • Reduce the risk of insolvency by encouraging the creation of emergency funds and streamlining cash flows.

What are the 5 principles of cash flow?

Businesses can efficiently and effectively manage their cash flows by adhering to cash flow principles. So, what are the 5 principles of cash flow management?

  1. Accelerate cash inflows through active accounts receivable management, timely invoicing and sending out payment reminders, offering discounts for early payment, and enforcing strict credit policies.
  2. Maintain low inventory levels to minimise carrying costs, optimise working capital, improve cash flow position, and keep the business model agile.
  3. Delay cash outflows by strategically negotiating better payment terms with vendors and creditors, availing of early payment discounts, and optimising payment schedules.
  4. Maintain adequate cash buffers to provide for unexpected events requiring major cash outflows, such as during COVID-19. Ideally, an emergency fund must hold funds totalling at least six to eight months' worth of expenses.
  5. Deploy idle cash into high-income-generating investments to create additional revenue streams, while closely tracking your cash flow position in real-time.

Techniques for managing cash flow

Companies can improve their operational efficiency and financial position by undertaking the following cash flow management strategies and techniques:

  • Perform cash flow analysis on a continual basis to keep track of any material changes in the cash position.
  • Explore financing options to pursue significant capital investments rather than draining cash outright.
  • Prefer leasing out or selling unused equipment in times of a cash crunch.
  • Optimise working capital by pruning excessive expenses, improving collections, and maintaining adequate inventory levels.
  • Leverage technology, such as a cash flow management tool that automates collections by sending timely reminders to suppliers.

Key Takeaways

Firms can achieve financial resilience, seize investment opportunities, and traverse economic uncertainty by adopting a proactive approach to cash flow management. They must conduct regular cash flow analysis by forecasting their revenues and expenses and take corrective measures preemptively to avoid any pitfalls from a severe cash crunch.

Cash Flow Management: Steps, Principles and How-To (3)

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As an expert in financial management and cash flow, it's evident that the article comprehensively covers the importance and strategies related to effective cash flow management for businesses. The information provided demonstrates a depth of knowledge in the following key concepts:

  1. Cash Flow Management:

    • Definition: Cash flow management involves analyzing, monitoring, and optimizing the inflow and outflow of money from a business.
    • Components: It includes tracking cash inflows (cash sales, payments, interest, loans, investments) and outflows (raw material purchases, salary payments, rent, taxes).
    • Objective: The primary aim is to ensure that cash inflows exceed outflows, enabling businesses to reinvest for growth while maintaining adequate liquidity.
  2. Objectives of Cash Flow Management:

    • Better Cash Flow Control: Limits cash outflows, accelerates cash inflows, reduces operational and tax expenses.
    • Ensure Adequate Cash Reserves: Helps maintain flexibility for unforeseen circumstances and unexpected costs.
    • Pursue Growth Opportunities: Enables systematic planning for asset purchases and business expansion.
    • Optimize Cash Holdings: Understands and utilizes excess cash effectively through investments.
    • Maintain Regulatory Compliance: Assists in proper maintenance of accounts, preventing errors in financial records.
    • Support Clear Communication: Enhances transparency in financial communication with stakeholders.
    • Ensure Business Continuity: Facilitates long-term continuity by maintaining optimal cash reserves.
  3. Examples of Cash Flow Management:

    • Adequate Cash: The example illustrates a company with a healthy cash flow cycle, allowing time for processing receipts.
    • Potential Cash Shortfall: Demonstrates a scenario where a lack of cash buffers could lead to challenges in seizing investment opportunities.
  4. Cash Flow Management Process:

    • Projections: Estimating revenues and expenses for the upcoming weeks based on historical data and projections.
    • Cash Flow Statement: Categorizing cash flows into operating, investing, and financing activities for a holistic view.
    • Monitoring: Regularly tracking and updating actual cash flows compared to projections.
    • Corrective Strategies: Taking action to streamline cash flow issues, including accelerating collections and reducing unnecessary expenses.
  5. Importance of Cash Flow Management:

    • Positive cash flows indicate the ability to meet expenses, service debt, and invest in growth opportunities.
    • Negative cash flow can hinder scaling operations, leading to the failure of startups.
    • Effective cash flow management helps improve liquidity, monitor spending, meet financial obligations, and reduce the risk of insolvency.
  6. Principles of Cash Flow:

    • Accelerate Cash Inflows: Active accounts receivable management, timely invoicing, discounts for early payment.
    • Maintain Low Inventory Levels: Minimize carrying costs and improve cash flow position.
    • Delay Cash Outflows: Negotiate better payment terms, avail early payment discounts, optimize payment schedules.
    • Maintain Adequate Cash Buffers: Create emergency funds for unexpected events.
    • Deploy Idle Cash: Invest in income-generating opportunities while tracking cash flow position.
  7. Techniques for Managing Cash Flow:

    • Continual cash flow analysis to track changes in the cash position.
    • Explore financing options for significant capital investments.
    • Leasing or selling unused equipment during cash crunches.
    • Optimize working capital by controlling expenses, improving collections, and managing inventory.
    • Utilize technology, such as cash flow management tools, to automate processes.

In conclusion, the article provides a comprehensive guide to cash flow management, covering key principles, techniques, and the importance of maintaining healthy cash flow for business sustainability and growth.

Cash Flow Management: Steps, Principles and How-To (2024)
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