Tips for Effectively Managing Cash Flow

Whether you are a small startup working on your proof-of-concept or a larger corporation exploring new markets, managing your cash flow effectively can make or break your company's success. 

Cash flow management is a critical aspect of running a successful business. Without proper cash flow management, your business will struggle to pay bills, meet payroll obligations, and grow their operations. Understanding the concept of working capital requirement (WCR) and its impact on cash is also very important.

In this blog post, we'll provide various tips for effectively managing cash flow and optimizing working capital requirement (WCR) to help businesses succeed.

                                                                                                                                                                                                                        Two concepts to understand: Cash flow and Working capital requirement.

                                                                                                                                                                                                                        What is Cash Flow?

                                                                                                                                                                                                                        Cash flow refers to the movement of cash into and out of a business over a specific period. Positive cash flow means that a business has more cash coming in than going out, while negative cash flow means that a business has more cash going out than coming in.

                                                                                                                                                                                                                        The Cash flow comes from a variety of sources and is usually broken down into 3:

                                                                                                                                                                                                                        Cash Flow from Operations, meaning from the company’s main business activities. These activities may include buying and selling inventory and supplies, along with paying salaries.

                                                                                                                                                                                                                        Cash Flow from Investing activities, to understand cash spent on property, plants, equipment, etc.

                                                                                                                                                                                                                        Cash Flow from Financing activities, to measure cash flow between a company and its owners and creditors (debt, dividends, etc.)

                                                                                                                                                                                                                        Effective cash flow management involves ensuring that there is always enough cash on hand to cover the various activities of the company.

                                                                                                                                                                                                                        What is Working Capital Requirement (WCR)?

                                                                                                                                                                                                                        Working Capital Requirement (WCR) refers to the company’s short-term financing needs caused by gaps between expenditures and collections linked to the business operations.

                                                                                                                                                                                                                        For example, before collecting a sale from a client that has a 30 days payment terms, the company has to finance the purchase of the inventory to a supplier that only gives payment terms of 15 days. 

                                                                                                                                                                                                                        To calculate the WCR, you have to look at the Balance Sheet and identify the current assets and liabilities. Current assets include inventory, accounts receivable, and cash on hand. Current liabilities, on the other hand, includes accounts payable, short-term loans, and accrued expenses.

                                                                                                                                                                                                                        WCR = Current Assets - Current Liabilities.

                                                                                                                                                                                                                        If your WCR is positive, your company has to find a way to finance its short-term requirements. If your WCR is zero, your company has enough operational resources available to cover all requirements. Now if your WCR is negative, your company has no short-term financial requirements.

                                                                                                                                                                                                                        Now, it’s easy to understand that changes in WCR have a direct impact on your cash: 

                                                                                                                                                                                                                        When WCR increases, your cash decreases

                                                                                                                                                                                                                        When WCR decreases, your cash increases

                                                                                                                                                                                                                        Now that we understand the concepts of cash flow and working capital requirement and its impact on cash, let's explore some tips for effectively managing cash flow.

                                                                                                                                                                                                                        How can I Optimize my Cash Flow?

                                                                                                                                                                                                                        Forecast and monitor cash flow regularly

                                                                                                                                                                                                                        The first step in effective cash flow management is to create a cash flow forecast for the next 6 to 12 months that will be updated regularly (at least monthly). Don’t wait to be in the red zone to care about your cash flow, regularly updating your forecast is how you will understand how your cash flow can be optimized and anticipate the potential shortfalls.

                                                                                                                                                                                                                        Control expenses

                                                                                                                                                                                                                        Review your expenses regularly and identify areas where you can reduce costs. Consider renegotiating contracts with suppliers or reducing your overhead expenses. Even small cost reductions can have a significant impact on your cash flow and working capital.

                                                                                                                                                                                                                        Delay cash outflows

                                                                                                                                                                                                                        Remember that decreasing your WCR will increase your cash. Consider negotiating longer payment terms with your suppliers or leasing equipment instead of purchasing it outright (increasing your accounts payables will decrease your WCR). You can also consider deferring non-essential expenses to a later date.

                                                                                                                                                                                                                        Optimize revenues

                                                                                                                                                                                                                        Optimizing revenues can be done mainly by finding more customers (volume) or increasing your price (value). We will not detail these strategies in this article. 

                                                                                                                                                                                                                        Speed up cash inflows

                                                                                                                                                                                                                        Remember that decreasing your WCR will increase your cash, so you want to manage your accounts receivable. Do not allow too long payment terms and make it a priority that your clients pay on time. Consider offering discounts to customers who pay their bills early or incentivizing them to make payments online. You can also consider factoring or invoice discounting, which involves selling invoices to a third-party provider for a fee.

                                                                                                                                                                                                                        Optimize inventory / supply chain management

                                                                                                                                                                                                                        Remember that decreasing your WCR will increase your cash, so you want to manage your inventory level. You want to decrease as much as possible the average number of days that your business holds its inventory before selling it. This includes making sure you keep an eye at your inventory aging and minimize your old inventory items by selling them at a discount for example.

                                                                                                                                                                                                                        Maintain a cash reserve

                                                                                                                                                                                                                        Maintaining a cash reserve can provide a buffer in case of unexpected expenses or revenue shortfalls. A cash reserve can help you avoid having to rely on costly loans or credit facilities to cover short-term expenses. Aim to maintain a cash reserve equal to at least three to six months' worth of expenses.

                                                                                                                                                                                                                        Leverage technology

                                                                                                                                                                                                                        Technology can be a powerful tool for managing cash flow and working capital. Consider using cloud-based accounting software to monitor your cash flow in real-time and identify potential issues before they become problems. You can also use automated payment systems to speed up cash inflows and reduce the risk of errors.

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                                                                                                                                                                                                                        This blog article does not constitute professional or legal advice. It is only intended to provide general information on a subject.

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