Cashflow rules are simple: a business must generate more cash than it consumes. Trite as it may sound, cash is king—because even a successful business will go out of business if the flow of money flowing out is faster than the flow of money coming in.
Cash management, then, is about planning ahead and tying cashflow with what a business is trying to achieve and how it plans to do it.
Although the principles behind cashflow are not complicated, complexity can quickly creep into cashflow management in big and small companies.
Problems in bigger companies
In big companies, cashflow problems may arise due to poor planning or complexity.
1. Poor planning.
This is especially true in companies developing new products and services and who invest a large amount of their money in R&D projects.
Often those running the company may be visionaries who do not make time for financial reviews to see what has actually been happening rather than what was expected to happen.
Big-budget movie companies, for instance, are often notorious for running into problems when it takes longer to complete a major film. Unexpected problems may arise like interruptions to the filming schedule due to harsh weather in exotic locations; temper tantrums by producers, directors, or star actors; or problems in getting certain scenes right.
2. Complex organizations.
Sometimes an international company that is in ten to forty countries can have hundreds of bank accounts; consequently, banking regulations, government compliance issues, exchange rates, and taxation laws make it difficult to keep track of many moving parts at the same time.
Problems in smaller companies
In small companies, cashflow problems may arise due to owner issues, profit targets, labor productivity, and high operation costs.
1. Owner issues.
Sometimes owners don’t take a salary, don’t pay themselves enough, or pay themselves with distribution (rather than income from market value).
2. Missed Profit targets.
Sometimes profit targets are not met and the pretax profit is below ten percent. The result is that necessary adjustments are not made to keep the business healthy.
3. Labor productivity.
Sometimes labor costs can exceed profitability. A business can’t spend more on its labor than it is bringing in. Sometimes, salespeople don’t sell enough. Sometimes, experts with high salaries have to be hired to keep the business running, but there are not enough clients. While this is a common situation in startups relying on investment capital, if this imbalance continues for too long, a business will fail.
4. High operation costs.
Sometimes, a business can bring in high revenue but the costs of keeping the business running are higher.
7 effective cash management strategies
- Align payables and receivables. If creditors demand to be paid within a month but clients tend to pay every 45 days, there is a misalignment. One solution is to restructure agreements with suppliers and establish a late fee for clients.
- Forecast revenues and expenses for the entire financial year or beyond. By planning ahead based on fixed and variable costs and multiple revenue streams, it’s possible to foresee potential problems well ahead of time. This is especially useful in a seasonal business. Planning ahead allows a business to look into applying for a loan, getting more overdraft protection, or arranging for extended lines of credit long before it actually needs the money.
- Use advanced software. It’s actually remarkably easy to automate many aspects of cash management that don’t require human intervention. While human beings can often become forgetful or overwhelmed, the algorithms of cash management software solutions can run things without a hiccup.
- Periodically review operating costs and cut expenses. Often money is wasted in paying for things that can be purchased cheaper or that failed to work as planned. Unfortunately, these costs may actually be forgotten. Sometimes a business may have forgotten that it contracted for a service that is no longer useful. For instance, a company may be paying a monthly fee to a magazine’s classified ad department that runs ads on autopilot when it is actually getting most of its customers from online pay per click advertising.
- Optimize staffing. Understaffing means that one person does the work of several others. This can lead to high turnover as people get burned out, which creates the added expense of training them. Overstaffing means that there are more people than work to do. The right balance between labor and work saves unnecessary expenses.
- Diversify income sources. Companies that rely on only one or two major accounts will experience a cash shock should these accounts be discontinued. It’s important to always keep the pipeline full.
- Establish clear policies on cash management. This can range from who handles the money to online banking procedures to figuring out a reconciliation schedule. It can also include finding ways to save surplus income or alternatively finding ways to avoid cash reserves sitting idly in bank accounts.
Effective decision making
When a company can view its cashflow position and forecasts with confidence, it can make key decisions. By understanding current and future cashflow balance, treasury teams can put the organization’s cash to work efficiently.