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What Is Cash Flow Management? Complete Guide to Managing Cash Flow

  • Finance
  • Article
  • 6 min. Read
  • Last Updated: 03/07/2024

A business owner creates a cash flow management system

Table of Contents

Cash flow management should be at or near the top of every small business owner's priority list. After all, while errors in customer service or supply chain management are undoubtedly undesirable, cash shortfalls may result in unpaid bills or the inability to make payroll, which could hurt your business.

Incorporating cash management into the planning and budgeting process can help minimize liquidity issues and ensure you have the funds to pay your bills.

Here is a closer look at cash flow management and some keys to successfully managing this part of your small business.

What Is Cash Flow?

Cash flow is essentially the money that comes into or goes out of your business, including:

  • Payments made or proceeds earned from purchasing or selling investments of the business
  • Money moving between your business and its owners, investors, and creditors

Sales — and your account receivables — play the most critical role in cash flow management for small businesses. Without customers wanting to buy your products or services, no matter how much initial capital, loans, or investors you have, your business will not survive.

Remember, cash flow is different from profit. Profit is what you have left at the end of the month or the year after you've covered all business expenses incurred. Cash flow represents liquid funds moving into and out of your business.

Why Is Cash Flow Important?

Every business needs cash to pay bills, support operations, and fund growth. Understanding how cash flows in and out of your accounts can give you incredible insight into what you're spending your money on to generate business and if your cash usage is helping achieve your goals. Savvy business owners need to be forward-thinking and understand when it's best to set cash aside to cover future expenses rather than spend what's in a bank account. Smart cash management decisions are made with a holistic view of your company's liquidity needs and enable you to weather the difficulties of the business cycle.

Types of Cash Flow

Some cash flow is much more reliable and easier to forecast. In contrast, other types of cash transactions require multiple assumptions that could change as the economy or industry shifts around you.

The three main cash flow categories reported on a cash flow statement are:

  • Cash flows from operations: This category includes cash flows supporting your primary business purpose. Revenues from sales are operating cash flows into the business. Outgoing cash flows in this category include manufacturing costs, payroll, and the payment of vendor invoices.
  • Cash flows from investing: Investing activities include cash used to fund expansion or upgrades. This might consist of equipment purchases or payments associated with the purchase of another business.
  • Cash flows from financing activities: Cash transactions may also be used to finance the business through debt or equity. This includes cash received from stock issuances, bond proceeds, or cash outflows when paying dividends.

What Is Cash Flow Management?

Cash flow management is the process of forecasting the amount of cash available, analyzing how you can best use these liquid funds, and putting strategies in place to ensure that you have the money needed to support operations and fund future expansion. Company cash flow management strategies may include paying bills early to take advantage of discounts or reserving cash during peak sales periods to fund the costs of running the business during slower months of the year.

What Is an Example of Cash Flow Management?

You can easily put any cash flow management strategies into place to help maximize your company's liquidity. One cash flow management example involves taking steps to collect outstanding bills on time. This could mean adding a due date to your invoices rather than billing customers and letting them determine when they will send payments. Perhaps offering a discount for early payment can entice customers to pay faster. You may also want to set a policy to follow up on overdue bills after a certain period.

Why Is Cash Flow Management Important?

Actively managing cash flow can better prepare you for business difficulties. The more liquid your cash and other investments on hand, the better prepared you are to satisfy short-term obligations as they arise. Smart cash flow management often benefits companies in several ways, such as:

  • Improved ability to manage unexpected expenses. Day-to-day small business operations are often unpredictable, and resources might be limited. You can plan for expected overhead such as rent or utilities, supplies, and salaries, but the sudden loss of a repeat customer or unexpected equipment breakdown can throw your business off balance and temporarily increase your need for cash.
  • Better control of your business. Managing cash flow gives you more control and perspective on your expenditures. Understanding available liquidity guides you when deciding to innovate, introduce new products or services, or expand into new markets.
  • Increased access to financing. Bankers, lenders, and investors usually analyze cash inflow related to operating activities when considering requests for funding. A solid grasp of cash management can improve outcomes when applying for loans or seeking outside investment.
  • Funds available for expansion and growth. A positive cash flow allows you to reinvest and expand to increase your profits and customer base.

How To Manage Cash Flow

Constructing a cash flow management system should begin with forecasting and analytics. Understanding how you're currently using cash and identifying potential areas of shortfall can help you devise policies and procedures to maintain adequate liquidity.

Here are some steps that can help you manage cash flow:

Step 1: Determine Your Cash Flow Cycle

Map out your company's cash flow cycle by defining how long it takes to generate cash from your daily activities. This could be the amount of time needed to purchase parts or supplies, manufacture products, and receive payment for your sold products or services.

The shorter the cash flow cycle of your business, the more money you will have to pay your bills and start the cycle once again. If you have frequent cash flow cycles, you're technically more efficient as a business because you can quickly gain a return on your operations.

Step 2: Try To Increase the Cash You Generate per Cycle

If you fall short of cash within each cycle, you may need to find ways to increase cash receipts from sales to generate positive cash flow. To increase cash inflows per cycle, focus on strategies to raise sales volume, create larger profit margins, or reduce expenses and salaries. Alternatively, you can try to speed up your operational processes to generate more yearly cash flow cycles.

Step 3: Ensure You Have Enough Time and Resources

Nobody can talk and promote your business with the conviction and passion that you do. But if you spend all your time trying to generate cash in each cycle — applying for financing or loans or looking for investors — you're missing other opportunities to create more sales or promote and advertise your business. Ensure your business has the right resources to manage cash flow and everything else it takes to succeed.

How Do Cash Flow Problems Usually Start?

Many small businesses fall prey to common cash flow problems. But with an awareness of what some of these problems are, business owners can be proactive in their management of cash flow and hopefully avoid these issues:

  • Overestimating profit. Entrepreneurs and new business owners sometimes feel that all they must do is open a new store or website, and profits will follow quickly. This can lead to overspending in the early days and the chance that available cash will run out before actual profits accrue.
  • Not creating the proper budget. Generally, a cash flow budget covers the cash a business leader anticipates receiving (usually within the next 30 days) and what they gauge is the likely amount of money needed to pay out during the same period. Without this budget, a business can fall short when it's time to pay bills or compensate employees.
  • Neglecting to consider overhead costs. Expenses for a small business — everything from equipment purchases to worksite leases — can mount quickly. Business owners facing high overhead costs need to look for ways to decrease these costs to make room for profits and a smooth cash flow.
  • Not focusing on accounts receivable. You may be making many sales, but you could be in trouble if customers don't pay on time. The subsequent lack of available cash can undercut opportunities for growth and increase the difficulty of making your payments to vendors and others on time.

The dangers of cash flow problems to a new business are apparent. Yet even established businesses need to monitor how well cash flows in and out of the business to avoid encountering some of these and other cash-flow-related problems in the future.

How To Avoid Cash Flow Problems

Regardless of their level of financial expertise, business owners should do everything possible to avoid running into a cash flow problem. Here are key mistakes to watch for and additional ways to strengthen your cash management process:

  • Don't confuse sales figures with cash flow. Bringing in sales does not necessarily indicate that a company has funds on hand to pay bills when they're due. Sales only translate into cash flow when paid for your products or services.
  • Don't fall prey to poor planning. Successful small business owners don't wing it when managing cash flow. They create cash flow projections based on a close analysis of how they expect sales to look over the next 12 months and how much cash is likely to be paid out over the same time frame.
  • Set up cash flow reporting. Cash flow statements could signal if the business made or lost money from normal operations, if the company borrowed money, if it lent money, how much debt it paid back, and other factors. This type of analysis represents an essential source of financial data, particularly for seasonal businesses and those whose cash flow is often erratic.
  • Avoid delay of payment from customers. If possible, request immediate payment terms or a payment period of no longer than 10 days. You can facilitate "immediate payment" by using checks, credit/debit cards, or various electronic payment systems. Consider granting your employees the authority to accept payment through a customer's mobile device.
  • Don't overextend your available inventory. Optimistic business owners sometimes order surplus inventory they expect to sell in a given period. But over-ordering products could mean wrapping up funds in unnecessary inventory. This can be especially troublesome if your liquidity is negatively impacted. Idling inventory can siphon off funds you might use for new product development or refined marketing strategies.
  • Don't leave yourself without a cushion. While a business owner need not assume the worst will happen in the future, something unexpected could occur — in which case, money on hand may be the best defense. Even a small cushion for discretionary expenses or unexpected items keeps a budget flexible as business conditions change throughout the year.

Effective Cash Flow Management Strategies

Well-defined cash management strategies work to mitigate liquidity problems in your business. With the proper procedures, you can identify potential issues with cash transactions and follow up before depleting existing funds.

Some important cash flow strategies to consider include the following:

Find Effective Systems for Receiving Payments

Sometimes, business cash flow management issues occur when companies do not receive timely payments for goods and services. Fortunately, there are ways to fix this. If you tend to have a large amount of bills outstanding at any given time, options to explore include the following:

  • Revamping payment structure. Evaluate billing methods to determine if they match revenue generation while optimizing cash flow. If not, consider making changes, such as placing customers and clients on a monthly retainer package instead of sending and collecting individual bills for multiple more minor charges.
  • Monitor customers' creditworthiness. By assessing the customers you choose to do business with, you may be able to gauge their ability to pay you. Riskier customers may require stricter terms to avoid nonpayment issues.
  • Auto-invoicing via accounting software. Automatic invoicing refers to using accounting software that sends invoices for you. Many current accounting software solutions will follow up with an automated reminder if you haven't received a payment by a specific date.
  • Auto-billing customers. Auto-billing refers to clients and customers agreeing to be charged automatically on a recurring basis. This works best for retainer services, and services like PayPal or most e-commerce systems can do this for you.
  • Change invoice frequency. Business owners may also want to consider invoicing more often. For instance, consider sending updated bills bi-weekly instead of invoicing once a month. This helps ensure that there's always cash in the business account.
  • Request a deposit or partial payment. When it comes to orders of a significant size or the possibility of a long-term contract, consider requesting a 5 or 10% deposit before the start of the project. When work gets underway, charge half of what remains on the account, with the balance due after completion.
  • Explore mobile payment solutions. A variety of mobile payment apps use the power of your smartphone to accept payments by credit and debit card.

Evaluate Expenses Regularly

Just like people who manage personal budgets should keep an eye on expenses, so should business owners. If business owners are not careful, costs can creep up over time and possibly even overrun a business.

  • Know your return on investment. Business owners can audit past purchases by calculating a return on investment (ROI). Does the cost of the new machinery in your factory improve your output and profit? Granted, if you invested in upgraded software or a new hire, you'll need to give it some time before you know the answer.
  • Don't spend just because you have cash. Business owners should also take time to consider potential investments and expenditures. For example, do you need a new website now, or can it wait? By thinking through an investment rather than spending now and figuring out how to pay later, business owners can mitigate future cash flow problems.
  • Obtain a business credit card or line of credit. Having access to different lines of funding can help cushion your cash flow. Consult your bank or loan organization about the viability of obtaining a business credit card or line of credit. This helps extend your cash flow resources when they are needed most.
  • Lease instead of buy. Equipment purchases can be enormously expensive, and there are always costs associated with upkeep and maintenance. Look into leasing digital technology, other types of equipment, and vehicles. Leasing costs are often tax-deductible.

Maintain a Cash Flow Forecast

Look ahead for 6 to 12 months. What targets should you aim for, in terms of growth, while keeping cash flow intact? Are any seasonal factors involved? Do expenses rise during a particular time of year? What fixed costs can you expect? What about variable costs? Draft a cash flow forecast that's as comprehensive as possible.

How To Increase Cash Flow

While business owners can replenish cash flow with solid business sales and improved cash management, they may still need to increase cash flow further. If so, you can also employ some lesser-known strategies to ensure you have the liquidity resources you need.

  • Create a payment schedule for bills. Owners should carefully read invoices from suppliers to figure out when exactly their payments are due. Then, they should create a payment schedule that allows them to hold onto their money for as long as possible while taking advantage of any possible discounts.
  • Go paperless. Switching to a paperless format for invoicing and payments can reduce a company's paper and printing expenses. Electronic bills can be sent quickly rather than waiting for delivery by postal service. Some initial investments may be associated with implementing the technology to go completely paperless, but businesses should see a positive return on investment in the long run.
  • Determine your optimal cash cushion. Much like a personal budget, small businesses should keep a certain amount of cash on hand in case of emergencies. Maintaining adequate liquidity is essential, but reserving too much cash may cause businesses to miss profitable investment opportunities. Industry or regulatory standards may also play a role in determining a minimum cash reserve.
  • Perform a deeper analysis of your cash account. A statement of cash flows illustrates how much cash goes in and out of the business each period. You can get more extensive tracking via a cash journal, an even more detailed record of company transactions. Reports should be reviewed, and exceptions to normal expenditures should be noted to increase awareness of how money is spent.
  • Reconcile cash accounts to bank statements. You should reconcile cash balances to an external source like a bank statement. Review balances regularly and investigate any discrepancies. Establish separation of duties between those who handle cash and those who record transactions to mitigate misappropriation or employee fraud.
  • Enforce late payment terms. Once you establish a customer base, ensure you receive timely payments. Late payments affect the cash cycle and may cause companies to be unable to pay their bills from vendors and suppliers. To reduce cash flow problems, follow up with late customers on time, and enforce the late payment terms written into contracts.

Properly Managing Cash Flow Is Critical for Business Success

Proper cash flow management can carry a new business through the startup phase (and keep an existing business afloat). Rather than struggle as your organization grows, knowing how to manage cash flow and small business finances will help your company weather the inevitable ups and downs of the business cycle. To mitigate problems in cash flow for business operations, consider using accounting software to help pay bills, invoice customers, calculate and file taxes, and share financial data with an accountant.

Cash Flow Management FAQs

  • How Is Cash Flow Calculated?

    How Is Cash Flow Calculated?

    You may be able to look through your bank statement to help determine how much cash went in and out of your business each month. Simply adding up all cash inflows, such as receipts from sales, and subtracting cash payments, such as payroll and bills, will give you a net cash flow number. This is the direct method of calculating cash flows and can be used by less complex businesses that use the cash basis of accounting.

    Accrual-based businesses will need to make additional adjustments to their cash flow calculations. The indirect method of calculating cash flow considers non-cash transactions such as account receivable increases or rent prepayment. Inventory changes, a non-cash asset, must also be factored into the indirect cash flow formula.

  • What Is the Free Cash Flow Formula?

    What Is the Free Cash Flow Formula?

    "Free cash flow" refers to the cash left over after a company has paid its expenses for a set period. Free cash flow is calculated as follows:

    Net Income + Depreciation / Amortization – Change in Working Capital – Capital Expenditures

    Like the indirect method of calculating cash flow, the free cash flow formula considers noncash transactions, such as depreciation. The change in working capital refers to the money used to fund the daily operations of the business, calculated as current assets minus current liabilities. Capital expenditures represent the purchase or sale of assets intended to be held for one year or more.

  • What’s the Difference Between Negative Cash Flow and Positive Cash Flow?

    What’s the Difference Between Negative Cash Flow and Positive Cash Flow?

    When calculating company cash flows for a set period, such as one month or one year, a negative result indicates that the company spent more cash than it took in over the reporting period. A positive cash flow result shows that more cash was generated than was spent.


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* This content is for educational purposes only, is not intended to provide specific legal advice, and should not be used as a substitute for the legal advice of a qualified attorney or other professional. The information may not reflect the most current legal developments, may be changed without notice and is not guaranteed to be complete, correct, or up-to-date.

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