What Is Cash Flow Management?

Cash flow management is crucial for small businesses, ensuring they can pay bills, cover supplies and materials for production, or pay employees. Improper cash flow management may lead to an inability to make payments on time, leading to decreased business growth and negative repercussions.

Discover more about how cash flow can benefit your business, how to measure cash flow success, and four simple steps to implement a cash flow management strategy.

Cash Flow Management Explained

Cash flow management strategies encompass many different parts of a business’s finances. To successfully implement an adequate cash flow management strategy, you should have a basic understanding of how cash flow helps you maintain good financial health.

Benefits of Managing Cash Flow

Cash flow management is essential for several reasons, especially for small businesses that may not have the finances of larger enterprises to cover expenses. Consider the following benefits of having a positive cash flow:

• You can cover expenses on time. You won’t need to worry about being late on bills or not being able to buy supplies to create products. And you’ll have enough funds to cover your payroll.
• You can plan and make more informed decisions. Looking at patterns in your revenue and expenses and average cash flow over time can help you create budgets and plan for investments and growth.
• You can set up an emergency fund. When managed correctly, periods of positive cash flow can be put aside as savings for expenses during slow times. This will help ensure you can keep cash-flowing assets instead of going into debt.
• Your business will better qualify for financing. Banks will look at your general financial situation, including your cash flow statements and ability to repay loans.

Overall, effectively managing your cash flow will help your business run smoother and have more opportunities for financial success.

What is the Difference Between Cash Flow vs. Profitability?

While positive cash flow may seem similar to profit, there is a distinct difference between the two.

• Cash flow: Indicates how much money is moving in and out of your business at any given time
• Profit: Is the amount of money that is left after you’ve covered all of your expenses

Therefore, making a profit with varying cash flow patterns is possible.

For example, in the first week of any given month, you might experience a negative cash flow because your expenses exceed your available cash. However, the next week, you might have a positive cash flow that allows you to cover the rest of your expenses and have some money left over. Your profitability is how much money you have left at the end of the month when all of your bills, payroll, supplies, and other operating expenses have been paid.

The Two Principles of Cash Flow

The two main parts of cash flow include cash inflows and cash outflows.

1. Cash inflows

Any amount of money coming into your business, such as payments from customers, bank account interest, investment or loan funds, or cash-flowing assets like stocks and bonds

2. Cash outflows

Any amount of money moving out of your business, such as supplier payments, operating costs, payroll, taxes, capital expenditures, or loan payments

The inflows and outflows in your business can help manage your everyday finances. You can predict cash flow patterns better when managed effectively, allowing you to create more accurate forecasts and budgets.

Key Metrics and Formulas for Managing Cash Flow

You can use many different metrics and formulas to measure your cash flow. A solid set of these measurements can give you a good idea of your business’s financial standing.

Operating Cash Flow Formula

Your operating cash flow gives a general idea of how much money has moved in and out of your business. It is typically listed first on the cash flow statement. You can calculate it by using the operating cash flow formula below:

Operating cash flow = Net Income + Non-Cash Expenses + Change in Working Capital

Working Capital Formula

Your working capital is also hugely important when investors or banks consider funding your business. It measures your business’s liquidity or how quickly you can convert assets into cash. A working capital over 1 means your business can pay its current liabilities. The working capital formula is:

Working Capital = Current Assets / Current Liabilities

Forecast Variance Formula

Since forecasting is such a crucial reason for cash flow management, you can also calculate forecast variance (the difference between your forecast and the actual results) with the following formula:

Forecast Variance % = [(Forecast - Actual) / Actual] x 100

Other Key Metrics

Finally, you can get a good idea of how quickly you make and receive payments by tracking metrics such as:

• Days sales outstanding
• Days payable outstanding
• Accounts receivable turnover
• Accounts payable turnover

4 Steps To Manage Your Business’s Cash Flow Effectively

Use the simple four-step system below to begin your business’s cash flow analysis and make improvements to your business’s finances.

1. Outline Your Financial Obligations To Forecast Expenses

Forecasting expenses is relatively simple but requires a deep-dive look into how your business spends its money. Your money will go into three main areas: operating expenses, payroll, and liabilities.

The individual items in these categories can also be defined as fixed and variable expenses. Your fixed bills are the ones that stay the same. You should know exactly how much these will cost. Alternatively, your variable expenses will vary, but you should be able to estimate how much they will cost.

Operating Expenses

Your operating expenses may include:

• Day-to-day purchases
• Rent and utilities
• Supplies and materials
• Marketing

Payroll

Payroll is another operating expense, but it’s a major one, depending on how many employees your business has. You should have a breakdown of each employee’s salary or hourly wages. You can then calculate how much your payroll will be for your given period and add it to your other operating expenses.

Liabilities

Your liability expenses will include any payments that go toward debt. If you are repaying a loan or an investor, you can list your payments to add up how much you will need to manage your liabilities.

It may be a pretty long list, but having a detailed view of how much your business will spend can help you begin to see patterns in your spending, when you’ll need more money, and even whether you can eliminate some of your expenses.

2. Look at Previous Cash Flow Statements To Forecast Revenue

Previous cash flow statements can help you identify your business’s revenue patterns. While forecasting can be difficult due to the many factors that affect revenue, you can use your historical data as a starting point. Short-term forecasting is generally more accurate and can help determine day-to-day cash flow. Meanwhile, long-term forecasting gets more complicated and is more helpful in guiding overall business strategy.

Short-term forecasting may be more helpful for initially managing cash flow. Focus on six months or less, then break that period into shorter periods, such as weeks. Then, you can begin listing all of your expected income. This might include:

• Customer sales
• Monthly recurring revenue (MRR)
• Contributions from business owners
• Loans or investments
• Tax refunds
• Any other type of cash inflow

Use previous cash flow statements to guide this process.

3. Review Your Finances and Test Cash Flow Projections

Once you’ve calculated both your expenses and revenue, you can break each down by period. Finally, subtract your expenses from your revenue to determine future cash flow. After you’ve created these projections, all that’s left to do is conduct business and see how your cash flow forecasts compare to your actual performance.

4. Conduct Financial Audits To Optimize Cash Flow

To increase cash flow, you must review your financial statements and adjust your strategy regularly. You should use your current and past cash flow reports and repeat the steps above to help you track inflows and outflows. You can also consider the following actions to help optimize your cash flow:

• Keep a cash reserve, credit card, or business line of credit: This can help you manage cash flow issues if you have unexpected expenses or lower-than-expected income.
• Set up payment terms that allow you to balance customer satisfaction and getting paid on time: Consider offering payment discounts to customers who pay early to avoid late payments. Practice revenue recovery to reduce customer churn and improve successful payments.
• Be strategic about timing outflows, such as vendor payments, with inflows: Communicate with suppliers to set up payment schedules that delay payments until necessary.
• Negotiate better supplier terms: Shop around for competitive pricing on products and see what you can do to get the most value for your dollar from any existing partners.
• Use transparency and ethical pricing models. This can help you effectively increase prices while still offering value to your customers while increasing your cash flow.

Set aside time regularly to review your cash flow and other aspects of your business’s finances. All parts of your finances are connected in some way, and you can make plenty of changes over time to continue improving your cash balance.

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