Cash Flow Management

Cash flow management monitors and forecasts a business’s cash inflows and outflows to enable business continuity and growth.

As the saying goes, “Cash is king.” Cash flow management is crucial for businesses of any size or level of profitability. It ensures that business expenses are met and growth plans can be realized.

What is cash flow management?

Cash flow management is the process of monitoring, optimizing and controlling how cash moves in and out of a business. Managing cash flow involves a daily analysis of available cash on hand and expenses. This allows the business to financially plan for day-to-day operations, customer demand and growth investments.

A positive cash flow means that more money is going into the business than leaving it, while a negative cash flow indicates that the business is spending more than it has coming in. A business may still experience a negative cash flow even if its sales are high. This is because lengthy payment terms can leave businesses waiting weeks or months for cash while expenses accumulate.

How to manage cash flow

At their core, effective cash flow management strategies monitor cash flow metrics and forecast cash flow regularly. Measuring money inflows and outflows helps businesses plan for short-term expenses, while forecasting anticipates cash flow over days, weeks, months, quarters and even years. Some common metrics used to monitor and manage cash flow include:

• Operating cash flow ratio: Indicates whether the business earns enough from its core business activities to pay its bills.

• Operational cash flows / Current liabilities = Operating cash flow

• Cash ratio: The business’s liquidity, signaling whether it can pay short-term debts and other financial obligations should the business fold.

• (Cash + cash equivalents) / Current liabilities = Cash ratio

• Available working capital: The immediate cash available to cover expenses and potentially for growth investments.

  • Current assets – Current liabilities = Available working capital

• Cash conversion cycle (CCC): The average number of days it takes to turn inventory and other investments into cash from sales. The cash conversion cycle is calculated from three other metrics:

• Days sales outstanding: The average number of days it takes for inventory to turn over.

  • Days inventory outstanding: The average number of days it takes for invoices to be paid.
  • Days payable: The average number of days it takes a business to pay its bills.
  • If you put them together, you get the following formula:
    • Days inventory outstanding (DIO) + Days sales outstanding (DSO) – Days payable outstanding (DPO) = CCC

• Free cash flow: The cash available for growth investments after capital expenditures are covered.

  • Operating cash flow – Capital expenditures = Free cash flow

Other cash flow management strategies

Businesses that diligently monitor and forecast cash flow are equipped to predict both shortages and surpluses, and adapt accordingly. To mitigate deficits and optimize excess cash, businesses may incorporate the following into their cash flow management strategies:

• Operations reviews. Businesses that struggle to maintain a healthy cash flow may assess the business for cost-saving opportunities. For example, this might involve automating administrative processes or negotiating lower vendor pricing.
• Inventory management systems. Streamlining inventory management can help businesses avoid cash flow issues caused by overstocking and understocking inventory.
• Emergency buffers. Businesses with surplus free cash flow may set aside some of that capital as a buffer if they forecast declining cash flow in the weeks or months ahead.
• Early payment incentives. Profitable businesses can still face cash flow problems when customers have lengthy payment terms. Offering early payment discounts helps speed up receivables and boost cash flow.

Why is cash flow management important?

Cash flow is often cited as the primary reason that businesses fail. Without sufficient cash, businesses may be unable to afford daily operations or make the investments needed for growth. Many businesses also require bank loans or other financing to operate and grow. Without effective cash flow management, businesses may lack the financial standing to qualify for funding.

Factors such as lengthy payment terms, customer nonpayment and seasonality can send even highly profitable businesses into a cash flow crisis. Cash flow management not only helps early-stage businesses get on their feet and maintain operations, it also enables profitable businesses to free up available working capital and ensure sustainable growth. It’s also valuable when an economic downturn may limit funding options or disrupt demand.

The benefits of cash flow management

• Business continuity. Cash flow management helps businesses meet financial obligations and keep up with customer demand, especially if they are small to midsize or not yet profitable.
• Funding eligibility. Managing cash flow effectively helps build the financial history and metrics needed to attract investors and meet business financing requirements.
• Sustainable growth. Cash flow management facilitates smart growth decisions, helping avoid stagnation or unsustainable, rapid growth.
• Resilience. Businesses that practice effective cash flow management are more likely to survive economic downturns, inflation and other market disruptions.

Other Terms

• Cash Conversion Cycle
• Days Inventory Outstanding (DIO)
• Dynamic Discounting
• Early Payment Discount
• Free Cash Flow
• Implied APR
• Invoice Factoring
• Invoice Payment Terms
• Source-to-Pay
• Supply Chain Finance