Cash flow is the lifeblood of business. Without it, a business cannot fulfil its financial obligations on time, advises Jesse Weinberg, Head of the SME Customer Segment, FNB Business. Obligations include paying suppliers, staff salaries or taxes.
“The goal of cash flow management is to ensure that the business has enough cash at any point in time in order that the business is able fund payments it is required to make,” says Weinberg.
Weinberg answers all your frequently asked questions (FAQs) about managing cash flow, including how to improve your cash flow process.
The Difference Between Cash Flow, Sales, Revenue and Profit
Cash flow is related to sales, revenue and profit but it is not the same thing. Cash flow means exactly that “cash flow” and measures the actual amount of money you have either in your bank account or in cash, to use to make payments.
Sales, revenues and profits almost always include other non-cash items in the calculations such as depreciation expense on equipment or discounts, and they also do not always reflect the timing of payments. An example of where a sale happens at a different time to the payment is if you sold goods or services to customers on credit, you would only receive the payment for it at a later date as agreed in terms which could be a month or more later.
Why Cash Flow is Tricky
Cash flow is often tricky mainly due to the difference in timing of when money is coming into the business versus money being paid out of the business.
You may, for example, have a profitable business according to what your monthly sales and expenses look like, but if you haven’t received payment for those sales by the time your business is required to pay its suppliers for the stock you bought, you actually don’t have a healthy business despite it being profitable on your income statement.
Cash flow management often requires simple but a very disciplined level of attention to constantly keep track of how much cash your business has available at any given point.
Processes To Track Cash Flow
One of the most effective, simple and cost-effective ways to track cash flow is with a basic spreadsheet for example using either Microsoft Excel or Google Sheets.
A business owner should set up a spreadsheet (or a collection of spreadsheets) that will empower a business owner to constantly track the dates of all separate items of money coming in (receipts) and payments going out in any given month, as well as anticipated receipts and payments.
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How to Determine Sufficient Cash Flow
Quite simply use a spreadsheet to list all known cash that has and will be paid to the business (receipts), by when, and compare this to all the known payments that the business has made or needs to make. If there is more cash received than is required to be paid, then the business has a sufficient or “positive” cash flow.
The Dangers of Poor Cash Flow
The dangers of poor cash flow are that the business could ultimately go bankrupt if it finds that it is not able to meet its financial obligations as a result of not having enough cash on hand to make payments and meet its financial obligations.
Even in the short term, not having enough cash flow could present all sorts of challenges such as not being able to pay your staff on time, incurring penalties/fines for late payments and many other unfortunate events which can harm your business sooner or later.
VAT and Cash Flow
VAT-registered businesses are required to charge VAT on their vatable sales (on which VAT must be paid) but are also entitled to offset or even claim back VAT paid on certain vatable expenses/purchases. The result is that the business either needs to pay over a calculated VAT amount to SARS, requiring cash on hand, or it could mean the business may even receive cash from SARS depending on the specific situation.
How to Maintain Good Cash Flow
There are many measures a business owner can implement depending on the type, size and nature of their business. Examples of these include:
1. The most basic measures are around constantly striving to ensure that you continuously look to increase sales, whilst improving cost efficiencies in your business by reducing wasteful expenditure and efficient levels of stock purchases at the best prices.
2. Do your best to ensure you get your customers to pay you as quickly as possible especially where they haven’t paid you on the agreed date. Where you can try to avoid giving your customers the option to purchase from you on credit and try to get “cash on delivery” terms. If you do sell on credit, looking at incentivising customers to pay their account early with an “early settlement discount” is a popular method of encouraging payments to be made sooner, but you need to weigh up the discount as an expense.
3. The opposite applies when paying your suppliers: you want to try paying your suppliers as late as possible but without breaching the agreed terms or relationship with them. Additionally, you should constantly try to negotiate credit terms with your suppliers to give you a longer period in which to pay. This is especially important if you can foresee ahead of time that you may have cash flow challenges in your business. Even if you do have healthy cash flow in your business, obtaining favourable credit trade terms with your suppliers is well worth the effort just in case of unforeseen cash flow problems that may arise (these processes could take time; rather go through the process when you do have time on your side).
4. Lastly, it is always prudent to consider putting in place a backup plan, for example in the form of a credit facility from your bank. The type of product/facility will vary and be subject to your business’s financial standing, but an example of this could be a credit overdraft facility on a business bank account that will allow your business to go into “the negative” up to a certain limit.
The cash flow of a business can change suddenly, for example, due to rapid sales growth or unforeseen circumstances. More often than not, business owners wait until it’s too late to explore and implement such backup plans; it can take time and effort to obtain credit from suppliers and/or a bank so it is generally advisable to try to get this in place even if your business doesn’t seem to have cash flow problems.
The best time to create backup plans is when you don’t need them!
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