As you know, cash flow is the mainstay of any business. Yet despite its importance in running a healthy operation and accelerating growth, even the most profitable businesses can struggle with cash flow.
In fact, 54% of SMEs surveyed in the United Kingdom, Germany, France, Italy and the United States named cash flow problems as their biggest obstacle in business growth. While 76% said they rely primarily on cash flow from operations to survive and grow.
One of the biggest problems is knowing how to successfully regulate income and control expenditure. While maximising sales at all costs may seem like a priority to some, what’s the point in having impressive top-line figures if it’s taking you too long to collect your receivables and you’re unable to keep up with your payables?
In this article, you’ll find tried and tested methods that address this fundamental issue and enable businesses to get their cash flow on the right track.
1. Find the best liquidity ratio for you
A good place to start improving cash flow is to determine a consistent metric of your current cash in hand. There are multiple ways to do this, however, liquidity ratios are one of the most effective financial metrics. They help businesses quickly determine a debtor’s ability to pay off current outstanding debts and its financial safety margin, without increasing external capital.
In contrast to solvency ratios which assess a debtor’s longer-term ability to pay ongoing debts, liquidity ratios focus on short-term obligations and cash flows.
While there may be multiple liquidity ratios, you should only use one form and stick with it. Using different liquidity ratios and comparing them will paint a false picture of your current situation.
Once you find an ideal way of reporting and accounting, you’ll have a baseline to improve upon. This is essential in monitoring your progress from quarter to quarter to see if your new methods are working.
Common liquidity ratios
The current ratio
This liquidity ratio measures a business’ ability to pay off its current liabilities with its current assets (cash, inventories, account receivables). The higher it is, the better your liquidity.
Current ratio = current assets / current liabilities
The quick ratio
This common liquidity ratio, otherwise known as the acid-test ratio, measures a business’ capabilities of meeting short-term obligations with its most liquid assets. Note, the current assets don’t include inventories.
Quick ratio = (cash & cash equivalents + marketable securities + accounts receivable) / current liabilities
Days sales outstanding (DSO)
This liquidity metric is used to measure the number of days it takes a business to collect payment after it makes a sale. A higher DSO means a business is stunting cash flow and is tying up capital in receivables.
DSO = average accounts receivable / revenue per day
2. Identify cash flow gaps
Another useful way of regulating your current and future finances is to identify any potential cash flow gaps using these two cash flow formulas.
Cash flow statement
A cash flow statement looks a lot like a profit and loss statement and a balance sheet. Its purpose is to evaluate how cash moves in and out of the business, giving you a greater understanding of what impact cash flow has on the running of the business and how payments reconcile with cash balances and values.
A cash flow statement includes:
Once these three figures have been established, they can be either added or subtracted from the beginning cash balance to get the overall net cash balance.
Cash flow forecast
While a cash flow statement shows you the current cash flow in your business at any time, a cash flow forecast helps you predict what your balance will look like in the future.
Having access to this information will enable you to meet financial obligations by considering the current cash balance and adding or subtracting the forecasted cash inflows and outflows. From a planning perspective, it’ll help you make future decisions, such as knowing when to invest, recruit and take out loans.
To work out your cash flow forecast, simply add the amount of cash from sales, loans or investors you expect during the forecast period to your current cash balance. Then, subtract your expected cash outflows for the forecast period, such as loan payments, vendors, payroll and any other fixed expenses. The typical period for a cash flow forecast is usually made every week, month or quarter.
Cash flow forecast formula: current cash + projected cash inflows – projected outflows = forecasted cash
3. Get customers to pay on time
As well as knowing how to manage your business’ expenditure and analysing cash flow, it’s also essential to work on your debt collection process to reduce your average DSO (days sales outstanding) and ensure balances are being settled early or on time.
For a solution that incorporates these three areas, you should take a look at our innovative debt collection and management software. Using AI and automation, it’s designed to drive dialogue between businesses and customers to create an effortless repayment experience.
Instead of simply sending out a series of automated messages with no prior thought, our software analyses behavioural habits to help businesses use the right tone in its communications and deliver a personalised experience. Paired with our software’s on-demand payment option, customers are more likely to pay quickly and continue to work with you moving forward.
However, in extreme cases where your business needs cash immediately, you may want to resort to invoice factoring. This is the process of selling your unpaid invoices (for a small fee) to a company in exchange for an instant cash settlement. They’d then chase the payment. Just be aware, this option will often damage customer relations.
4. Liquidate old inventory
Old inventory is often one of the biggest business expenses. While you need inventory to make a profit, you don’t want an influx of something that doesn’t sell.
Whether you’re a part of an SME or startup, you can free cash flow by keeping tabs on your business’ sales patterns from month to month. If you have old inventory that you’re struggling to sell, think about liquidating them to keep the cash coming in.
Moving forward, you could always implement a just-in-time (JIT) inventory system which aligns your raw material requirements with your production schedule. This means, you will only ask manufacturers for the materials needed to fulfil a product or service once a customer has placed an order. This way, you’re making things to order and won’t have any old inventory sat around during quieter periods.
Or you could use Amazon’s free cash flow inventory model, which involves taking out credit with the manufacturers who make their own labelled products and paying them back over time while gaining instant cash flow from the customers who place an order.
This free cash flow model ensures businesses like Amazon can distribute their goods quickly for greater customer satisfaction, spreading the cost of expenditure and profit from the quick sale immediately. However, it’s worth noting that you need to have a low DSO and a firm grip on your month by month inventory to profit from this model.
5. Increase your prices
If your cash flow isn’t improving over time, it might be worth considering increasing the prices for your business’ products or services.
Research what your competitors are charging and assess whether the prices for equipment or inventory have increased. It’s also worth taking a closer look into how long current processes are taking to fulfil.
You need to find a happy medium between keeping your prices competitive while compensating the extra work or resources required to complete a job.
One of the best ways to increase your prices is to do it gradually and be transparent. If you drastically increase them overnight without prior warning, you’ll frustrate existing customers and put off potential new ones. There’s a whole psychology behind setting the right price, which includes using “charm pricing” to make sure your prices end in a “9” and “99”, as well as reducing the left digit by one.
Do it right and you’ll see an improved cash flow in a matter of months.
6. Address existing operating expenses
As mentioned earlier, improving cash flow isn’t just about increasing sales, it’s also essential to manage and reduce the cash leaving your business as much as possible.
Using the information from your cash flow statement, take a careful look at your expenses and break each expenditure down to see where your money is being spent. Ask yourself; is the expenditure necessary? Can you find a substitute?
Efficiency is another way of addressing operations and improving cash flow. This includes finding ways to streamline processes, such as automating communications in the debt collection process and purchasing better equipment that helps employees do their jobs more quickly.
Alternatively, leasing equipment instead of buying can free up cash flow too. The problem with a lot of modern technology is that it loses its value very quickly, especially when you’re dealing with laptops and desktop computers. Yes, you’ll lose the advantage of owning the equipment, however, you’ll be able to cut expenditure by paying lower monthly payments.
The final way of minimising your expenditure is to ask your current suppliers for bulk inventory rates. If you’ve been working with them for a long time, ask them if they can give you a special price on equipment or products by committing to their business for a set period.
The main thing to remember is to take just as much time analysing your cash flow as you would implementing new processes.
Gaining a clearer understanding of your expenditure, liquidity, forecasted cash flow and average DSO will enable you to develop a strategy that focuses on your business’ specific cash flow issues.
For instance, if it’s taking you too long to settle accounts receivables but your operating costs are minimal, you can spend more resources evaluating your business’ DSO and introducing new measures to speed up the debt collection process.
The better you become at successfully identifying the source of the problems, the less time you’ll spend on ineffective and non-relevant ways of improving your cash flow.
For further help maximising your cash flow, learn more about our innovative debt collection and management software. Using cutting-edge behavioural science, artificial intelligence, and automation, you’ll be able to streamline processes, improve the customer experience and boost cash flow within your business.
Or if you need some help working out your average DSO, then try our free DSO calculator.
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