Are you ready to understand how debt management impacts cash flow?
Read on to learn what cash flow debt management is and how to improve it within your business.
Starting a new business is always a risk – only 37 percent of start-ups in New Zealand exist after two years. And in Australia, 20 percent of businesses fail in their first year and around 60 percent will go bust within their first three years. From maintaining a steady base of customers to scaling a company, keeping a business functioning smoothly requires managing countless moving parts.
One of the most important factors of a successful business is financial planning and a fool proof strategy to have a positive cash flow and stay on track with debt management.
But doing this is easier said than done, which is why we’ve created the following guide for you to understand cash flow and how to improve it. Keep reading to learn how to keep your business finances under control.
What is cash flow?
Cash flow is the relationship between money coming into your company and money flowing out. For instance, the money a client pays you is cash in and the money you pay to your supplier is considered cash out. Everything leftover from this equation after your expenses have been paid is your profit.
Sources of cash coming into your business include product sales, service payments, sales of assets, outside investments, and loan proceeds. Examples of revenue flowing out of your company include salaries, production costs, operations costs, and the purchase of assets.
Cash flow is related to debt management because companies often go into debt when they don’t have the cash they need. So with the right cash flow, debt isn’t necessary (except when making a major planned purchase).
The key to understanding your cash flow is understanding the cash you have on hand when you start your accounting period vs when you end the accounting period.
Why cash flow management is important
Cash flow is one of the most fundamental parts of your company. If you don’t have enough cash, you can’t keep the doors open. Running out of cash is often the cause of failure of new companies.
Cash flow management helps you understand your company on a deeper level. By analysing your cash flow on a daily, weekly, and monthly basis, you can see trends that are causing your company to succeed or fail.
For example, you may identify a weekly cost that keeps popping up that isn’t actually benefiting the production of your services, or helping your team provide the best service to your customers. You can remove this cost – often referred to as “trimming the fat” and keep your cash flow higher.
So, how can you properly manage your cash flow so you don’t get into too much debt?
Ways to manage cash flow
Proper cash flow means keeping enough cash on hand to run your business while paying for your necessary expenses and making smart investments. Below we explain a few cash flow solutions.
Create an annual cash flow projection
Understanding how much money will come in and out of your company is a must. To do this as accurately as possible, you’ll have to create an annual cash flow projection.
Use a basic spreadsheet to begin, and you can create a way to measure how much money is coming in and how much is coming out. You can keep track of what you earn and spend in a given month.
Your annual cash flow projection will also serve as a guide for later years. Some months may be more profitable than others, and having this knowledge will allow you to adjust your business the following year so you optimise production and lower costs.
An annual cash flow projection is especially important if you’ve recently taken on debt to finance a new project or fund investment. You need to be confident that you have enough money coming in every month to fund your payments.
Keep a cash reserve
As soon as you start to generate sufficient cash, it’s time to start saving it in a cash reserve. For every period of success, there will also be a time when you need the extra funds. Having a cash reserve will give you a cushion when your business encounters unexpected obstacles.
Many companies make the cash flow mistake of buying major long-term assets. If you’re having trouble with cash flow, this is a mistake.
Here’s one of the most important debt management techniques: it could make better financial sense for you in this situation to finance or lease a major purchase so you can hang onto your cash reserves to keep your business going.
Regularly check profitability
When you first start your business, you may have a projection of what your costs and revenue will look like. In the beginning, the numbers will hopefully show you making a profit.
However, changing market conditions will lead to constant changes in pricing and costs. Suppliers may charge more for their products, and a new competitor may lead you to lower your prices.
It’s important to regularly check the profitability of your operations and make sure you’re staying ahead of the curve. If your company isn’t making a reasonable profit and can’t turn around soon, it’s time to consider another business model.
Collect receivables sooner, not later
Clients may like not having to pay invoices right away, but this is harmful to a business that wants a healthy cash flow. When it comes to invoicing, you should require that payments are due within a defined, and preferably short time frame, for example 14 or 30 days. We also recommend that you have an escalation plan in place, to manage any overdue payments. Download our sample escalation timeline.
You want your business operations to be balanced so you don’t find yourself short of cash even if you are receiving the amount of revenue that you need. By requiring payment immediately or soon after a purchase or delivery of services, you’ll keep the money coming in at the right ratio to the money you’re paying out in costs.
Take control of your financial plans
Keeping your cash flow balanced is not only key to your debt management, it’s the foundation of a healthy business.
Improve your business cash flow with the help of the smartAR team and transform your business. Contact us to learn more about how we can get started.