Cash flow – the steady and continuous movement of cash in a business operation – is essential for a growing business. Executives at small and middle market companies say that “stability of the company’s cash flow” is one of the top factors that will impact the business in the coming year.1
Businesses succeed when their leaders demonstrate a fundamental grasp of the cash flow dynamics for that company and its industry. A solid understanding of cash flow mechanics including the cash flow cycle and how it affects the efficient use of capital for funding will improve the success - and bottom line - of your business.
Why the cash flow cycle is important
Time really is money when accelerating your cash flow. How fast customers pay you and how quickly you can put your cash to work are the core metrics that make up your cash flow cycle. Understanding the three, basic cash flow cycle components provides you with insight and directs you to improvements to accelerate and enhance funds coming into and out of your company.
Your cash flow cycle is how long it takes to buy, build, sell and receive payment for your goods and services after you book an order. If your cash cycle is 45 days - 10 days after payment to receive parts, 10 days to build a product and 25 days to collect cash from your customer – you must keep working capital in the business to fund this cycle. In this example, your business is capable of 9 cash flow cycles annually.
Gross margin is the basic measure of cash produced from each product or service sold. Revenue is reduced by the direct material and labor costs. You make your cash work harder by generating the highest positive profit from each cash flow cycle.
You need to be aware of indirect costs, such raw material spoilage, inventory shrinkage or equipment financing costs. Non-product costs also might include time spent on collections, tracking employee expenses or idle time for workers waiting on raw materials. All of these expenses are a drag on cash flow, even if not evident on the income statement.
How working capital fits into the equation
Every business needs working capital to operate. Your business ties up cash because most employees, landlords and suppliers expect to be paid regardless of fluctuations in your cash flow. Managing that cash flow starts with tracking where your cash is going. Expenses such as labor, technology, and materials are highly visible and easy for owners to track using a standard profit and loss (P&L) statement. Manage expenses well, and you will reduce your need for working capital.
Conversely, get revenue in the door faster, and you reduce working capital needs. Whether you change terms to collect money closer to sale or raise pricing to generate more revenue from each sale, you can reduce working capital needs with more cash coming in.
Next come the balance sheet items that absorb capital. Grow your balance sheet, and you grow your need for working capital. Balance sheet components include:
Inventory carrying costs. Storing and handling raw materials, unfinished products or finished inventory tie up cash. Fast delivery and low inventory levels reduce cash needs.
Financing customers and suppliers. When you extend customers payment terms, you are essentially extending a short term, unsecured loan. Vendors providing credit are conversely lending you money that shows up on your balance sheet as accounts payable. Optimize by reducing customer terms as much as your customers will allow and extending supplier payments. On both fronts, using techniques to electronify collections and payments can tighten cash management and ensure that you maximize supplier credit received and minimize customer credit extended.
Financing equipment and plants. If you are in a capital-intensive industry that requires heavy machinery, specialized tools or expensive facilities, financing equipment or plants may absorb excess cash. Cash dedicated to capital investment in equipment and facilities can often by managed with capital leases, commercial and SBA loans and lines of credit.
Leverage tools to study and manage your company's cash
Available electronic and online tools make it much simpler to track and manage your cash flow.
Monitor and manage cash with online banking systems. Knowing how much cash you have on hand across your accessible accounts, as well as managing where and how that cash is spent, can be accomplished quickly and securely with online treasury management services. Real-time information for all your accounts is instantly accessible through a secure connection that allows you to view prior day and current-day balances for deposits, images of paper-based transactions, ACH, and wire reporting details and pending and posted transactions. Initiating account transfers, ACH, bill payments and even payroll gives you the flexibility to pay on time and easily take advantage of discounts, but control cash outflows by not paying earlier than necessary while avoiding late payment penalties.
Track and report cash flow seamlessly. Download online tools that sync with Quickbooks® and can seamlessly integrate your bank account information. Once integrated into your accounting software, you will be able to pay bills, download transactions, post unmatched transactions to your chart of accounts and transfer funds between accounts. These integration tools save time by avoiding double entry of transactions and account information and reduce manual entry errors.