Cash Flow 101: Tips for Management, Projection, and Long-Term Improvement

In this article, we take a look at one of the most important topics for just about any business: cash flow. This guide focuses on practical tips that will help business owners manage cash flow better, conduct the most accurate projections possible, and ultimately improve cash flow for their business.
In this article: 

What is cash flow and why does it matter?
6 Key Steps for Quality Cash Flow Management
Keeping Ahead of a Crisis with Cash Flow Projections
Creating a Plan to Increase Cash Flow

What is cash flow and why does it matter?

In the business world, you’ve probably heard the term “cash flow” thrown around quite a bit. It’s one of the most common benchmarks for understanding the state of your company and evaluating where you could streamline your operations.

Whether you’re a small business owner or Microsoft founder Bill Gates, analyzing your cash flow is an imperative exercise.

First, you should learn exactly what cash flow is, how short-term cash flow impacts your operations, and why it’s an important gauge of your company’s success.

What is cash flow?

At the most basic level, cash flow is the relationship between money coming into your company and money flowing out of it.

Think of an entrepreneurial business in its most basic form: a child’s lemonade stand. Cash flow is the balance between money coming in (cups of lemonade sold) versus the entrepreneur’s expenses (the cost of lemons, sugar, cups, etc.) Everything left over is profit.

What Comes In

Revenue is generated from a number of sources. It’s more than just the sales you make to keep your doors open. Some common examples of cash coming into your business include:

• Product sales
• Service payments
• Loan proceeds
• Outside investment in a company
• Sale of assets

What Goes Out

After all of that revenue flows into your company, where does it go?

• Production costs
• Worker salaries
• Operational costs (rent, utilities, office supplies, etc.)
• Principal debt service
• Purchase of assets

Understanding the cash you have on hand at the beginning of an accounting period in comparison to the funds left over after all the bills are paid is key to increasing your company’s profitability levels.

Short-Term Cash Flow Should Be the Focus

Now that you have the basics of cash flow, look at your finances on a more granular level: short-term cash flow.

This is the amount of money coming in and being spent on a daily, weekly, or monthly basis. It’s the day-to-day finances that keep your business running.

Taking a magnifying glass to your short-term cash flow has a number of benefits. By analyzing cash flow on this level, you’ll be able to identify what regular expenses are costing too much money.

By trimming this fat, you’ll have more control over your assets. You’ll have more insight into future planning.

Once you analyze your cash flow, you’re empowered to create a strategy to ultimately strengthen your business. We provide more insight on creating and executing a plan to improve your cash flow later in the article.

Careful Cash Flow Management is Essential

Cash flow is fundamental: even a profitable company can run into serious problems when forced to float too much cash. For example, among the 20 primary reasons that start-ups fail, the number-two cause is that they "ran out of cash," New York-based CB Insights said in a recent report.

CB Insights analyzed over a hundred startups, postmortem. (In case you’re wondering, the number-one cause was that the market didn't need the product a company was building.)

So, what steps can you take to properly manage cash flow?

#1: Check profitability and stay ahead of the curve on cash-flow management

First, make sure your company is earning a reasonable profit. If it’s not, then determine whether your products and services are appropriately priced and work to eliminate inefficiencies. However, be careful not to concentrate too heavily on profit.

Maintain your focus on cash flow and spending. Knowing your break-even point can be beneficial as well. While it won’t necessarily impact cash flow, it’ll give you goals to strive for and a ready-made target for forecasting where your cash should go in order to reach those goals.

#2: Create an annual cash flow projection

Mastering cash flow projections is a must. Using a basic spreadsheet as your tool, a cash flow projection allows you to see when money comes in when it goes out and what money is left at the end of each month after you’ve paid your expenses and recorded your income.

Knowing your numbers in terms of cash flow projection helps you to plan and anticipate for the coming months, identify potential shortfalls in cash balances; and see when problems or cash shortfalls are likely to occur so you can plan to avoid them.

Be sure to check your actual cash position regularly, such as weekly or monthly, against your projection to judge how you’re doing so you can pivot quickly when needed.

#3: Maintain a cash reserve

As soon as your firm begins to generate sufficient cash, establish a cash reserve. Shortfalls are to be expected despite the best-laid plans, especially in the startup phase.

Reserve cash can help see your business through changes in market demand and pay for unexpected business expenses. Alternately, a cash reserve can allow you to take advantage of business opportunities that arise.

Some companies make the common cash-flow mistake of buying major long-term assets, such as expensive equipment, rather than taking advantage of financing or leasing options. Consider that by paying for major assets over time, you’ll hang on to the precious capital you may need to keep your business going.

#4: Collect receivables immediately

When it comes to invoicing, require that payments are “due immediately” or with net terms no longer than 15 days.

Make it easy for clients to pay electronically (this brings money into your account quickly), charge interest to those who are slow to pay, and even offer discounts for early payments. Continually evaluate to see what works for you and how your customers are performing against your terms.

You want to make sure your customer terms and supplier terms are balanced so you don’t find yourself in a situation where you have to “float” cash.

Regularly check how your supplier terms stack up against others in the market. You might even discover that you're missing out on a discount if you were to pay earlier.

While this may run counter to your goal of shortening the receivables-payables gap, the money “saved” may be worth it.

Once you build a relationship with your suppliers, you may be in a position to negotiate for future discounts or payment terms better suited to your business cycle.

#5: Only spend on what is essential for your business

Through your annual cash flow projections, you’ll gain a solid understanding of your necessary expenses. Until your company becomes profitable, buy only the absolute essentials when you need them so you can reduce the amount of debt you accumulate and, thus, the financial risk you take with your business.

#6: Outsource non-core functions, such as finance, accounting, and HR

Outsourcing, rather than hiring, offers significant savings that can help reduce your cost structure. By offloading essential tasks to a trusted firm, you can focus your attention on your core business.

An outsourced CFO can help with financial projections, cash forecasts, operating budgets, financial plans, pricing, reporting, debt management, M&A, equity and debt negotiations, and liquidations.

Even if your financial status doesn’t warrant hiring a CFO, you still need financial support—from day-to-day accounting to regulatory compliance. Outsourcing your bookkeeping will give you the support you need for cash management, AP/AR, financial close, and taxes.

An outsourced human resources partner can help manage employee benefits administration as well as recruit new talent to your business.

It's important to understand that you don’t outsource to make a service disappear. As CEO, you must stay apprised of what’s happening as you outsource to reduce your cost structure and keep your internal resources focused on your business.

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Keeping Ahead of a Crisis with Cash Flow Projections

Strong knowledge of your business cash flow situation is a great foundation. This knowledge becomes even more valuable when it can be extended into future projections. As crises like the COVID pandemic have shown, however, past data won’t always be a reliable indicator in the face of a major business disruption.

It’s important to have a process in place to revise your cash flow projections in place whenever the business is confronted with a major disruption. These projections won’t be perfect, but they’ll give you an essential financial guidepost as your business works to adapt to any challenge at hand.

#1: Scrutinize Your Receivables

Receivables are usually a highly reliable predictor of how much cash will be coming in and when (this assumes your business model does not require full payment upfront).

Your Accounting team should be able to tell you the percentage of receivables that typically convert to cash in 30, 60, and 90 days, but the number of receivables on the books may not be realistic, and that aging pattern is likely to shift toward less timely payments.

Take a hard look at your current receivables– either individually or by category – and assess which of them are likely to be paid on time, which are going to be slow, and which ones may not be paid at all.

Consider using inputs such as a customer’s credit rating or industry to improve the forecast. Then, revise your A/R aging schedule to make credible predictions about cash inflows over the next 13 weeks.

Next, take a different hard look at how you collect your receivables.

Some companies are habitually laid-back in this regard, but now is not the time to be easygoing – your business depends on it. Consider ways to reduce any lags in collecting payments.

Do you need more frequent reporting on whether invoices are being sent out on a timely basis?

If customers who usually pay on time are slipping, get in touch with a senior contact at the company to gain an understanding of what is going on in the business – perhaps you can work out payment streams if customers cannot pay their entire balance on time. For chronic late-payers, you may want to require partial payment upfront, before filling their orders; however, that may be difficult, as almost every business will be trying to preserve cash.

#2: Revise Your Sales Forecasts

In normal times, sales forecasts are based on historical and recent trends, seasonal patterns, and perhaps some statistical analyses that incorporate the key sales drivers in an industry and target market.

Those techniques don’t mean much right now because they are based on business as usual, and this isn’t anything close to “usual”. In other words, forget the sales forecasts you made early in the year.

Instead, examine your sales pipeline – depending upon your business, you may be able to do this customer-by-customer – and be realistic about whether anticipated orders are going to close. If it isn’t feasible to do this on a customer-specific basis, re-forecast sales by customer segment, size, geography, or another category.

For example, if your business manufactures plumbing supplies, demand-driven by home repairs is likely to be different from demand arising from new home construction, so you should revise your sales forecast accordingly.

For current orders that haven’t been filled yet, decide which ones are going to ship, which may be reduced and which are at risk of being canceled. If you have a relatively small number of customers that usually place large orders, your sales team should get on the phone and have a conversation with each one of them.

Most companies (except those that manufacture critical medical supplies or provide other essential goods and services) will lose a large chunk of sales they had forecasted at the beginning of the year.

Right now, you need to take a hard look at how much revenue your business is likely to generate over the next three months.

Since everyone is facing extreme uncertainty, you need to be cautious about pursuing sales to customers who may not be able to pay you. You do not want to invest time and resources in booking sales and manufacturing products for customers who are likely not going to be able to pay.

Read More: 8 Sales Forecasting Methods to Improve Your Current Projections

#3: Reassess Your Inventory Needs

Inventory sucks up cash. Some of the inventory you usually carry to meet demand from regular customers won’t be needed over the next 13 weeks because some of those customers will cut back, some will shut down temporarily and some will go out of business. However, don’t stop production based on fear; inadequate inventory levels mean lost opportunities.

To help determine how much inventory you should carry now, look at your revised sales forecasts (see Step #2) and consider your average inventory-to-sales ratio for Q2 in recent years. If you’ve been in business since 2008, look at the ratio in Q2 2009 for additional insights.

You might consider reducing your product line. If you offer products in sizes, colors, or configurations that generate infrequent sales, consider eliminating them for now. If an order for one of these “temporarily discontinued” items comes in, you can decide at the time whether to use excess capacity to fill it.

#4: Analyze Your Payables and Other Expenses

Identify exactly when and where your business is spending cash. Review your P&L and accounts payable to identify every recurring expense, including supplies, payroll, rent, marketing, utilities, insurance, and IT infrastructure.

Calculate the amount spent per month for each one, and when those bills are paid.

If you will need to cut costs to avoid running out of cash in the next 13 weeks, everything should be on the table, but not all at the same time.

Some expenses may be fairly easy to reduce under the circumstances. For example, look at your travel budget (airfare, hotels, meals, entertainment, mileage reimbursement), and any amounts allocated for trade shows or conferences. Those can probably be slashed or eliminated entirely.

If your revised sales forecast and inventory needs suggest it doesn’t make sense to retain all of your employees, consider applying for a forgivable loan under the PPP (Payroll Protection Plan). If that isn’t a viable option, decide which key personnel you want to keep no matter what, and which ones are less critical.

If you have to let people go that you truly wanted to keep, let them know you’d like to bring them back as soon as you can (without making promises). At the same time, don’t cut out the small things that employees appreciate (such as free coffee or snacks). You want to signal to your workforce that you care about them. Remember, this is a stressful time for everyone.

Working through the steps described above will allow you to make a realistic, informed, useful cash flow forecast covering the next 13 weeks. Every week update the forecast. Yes, it is time-consuming, but it’s necessary.

Creating a Plan to Increase Cash Flow

So far, we have focused on steps intended to help get control of cash flow management and survive any acute threats to your business.

Over the long term, however, growing incoming cash flow is always the most important goal.

#1: Set Goals for the Future

Now that you’ve completed your self-analysis, you’re ready to outline the ideal state of your company and the goals you should achieve to make that a reality. First, ask yourself: Am I trying to run my business for growth or profitability? It’s often difficult to focus on both objectives, so you need to decide your goal before moving forward.

If you’re trying to maximize revenue, you should turn your focus to investing in resources, like high-performing employees or equipment to streamline your operations. While this is an important measure to take, don’t expect to see an immediate return on this investment. You’ll reap the benefits further down the line.

If growth is your objective, take a more strategic approach to managing your resources. Only make purchases when necessary and keep an eye on your expenses. When you take this approach, you’re more likely to have more cash flow coming in rather than going out, and minimizing these expenses increases your profitability.

#2: Make Your Plan Actionable

After determining your goals, develop an actionable strategic plan to increase your cash flow. Outline concrete steps to improve your financial standing. Start by creating annual action plans. What are you going to do over the next year to increase cash flow? Maybe one of your goals is to double the amount of revenue your sales team brings in.

Focus on quarterly objectives. When you’ve identified large actions you want to take over the next year, break them down into quarterly objectives. Take sales as an example. What is an action you could take this quarter to improve sales? One objective might be to bring in more leads. Identify how you’re generating leads and focus your efforts on those channels.

Identify monthly steps. Focus on monthly steps that bring you closer to achieving your ultimate goals. If you’re striving to boost sales, perhaps this month you could evaluate your sales process, identify inefficiencies and close the gaps.

Use your knowledge of finances and cash flow to plan out when you should be able to hit your objectives, what efforts you should make, and how to remove roadblocks that stand in your way.

In the next section, you’ll find a few concrete steps to help jumpstart your action plan.

#3: Implement and Evaluate

You’ve done the planning, so it’s time for implementation. Following through with your actionable business plan to increase the cash flow is essential to improving your company. To support your action plan, you need to manage your finances.

And, it doesn’t end with implementation. You should evaluate your efforts to determine if your plan is working. Keep your team accountable for their efforts by mandating monthly, quarterly and annual reports. If these efforts aren’t working, revise your plan and the allocation of your resources.

You won’t see a major increase in cash flow overnight. Sometimes it might be hard to start the business planning process on your own. That’s why turning to a financial partner and guide is ideal.

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Tips for Increasing Cash Flow

Every business is different, and cash flow optimization can look very different for different firms. But the following tips are a great place to start thinking about improving cash flow in just about any industry.

Tip #1: Change Invoice Timing

One of your greatest sources of cash is client payment.

Because so many of your business expenses are paid out of this pool of cash that comes in monthly, making changes to the timing of when your invoices are due has a big impact.

Make sure that the due dates on your invoices align with the due dates for your own bills. Often, businesses are accruing expenses before a client payment comes in, and those expenses can diminish your cash flow.

Try to send out your invoices as quickly as possible once a sale is made, and have fair, but short deadlines for payment. Making simple adjustments to your invoice process, like billing your clients every two weeks instead of monthly, will quickly increase your cash flow.

Tip #2: Change Invoice Terms

Timing is not the only change to your invoice process that can boost your on-hand cash. Adjust the terms of your invoices to incentivize early or on-time payment.

You have likely heard the term “net 30” in relation to invoice payment, referring to the due date being 30 days after the receipt of the invoice.

Perhaps “2% 10, net 30” is a better approach to invoice payment. This gives the customer a 2% discount if the payment is made within 10 days of invoice receipt.

This slight discount (a benefit to the client) incentivizes early payment (a benefit to your company.)

Tip #3: Communicate Regularly with Your Clients

Be upfront, frank, and open with your clients about prices, payments, and your invoice process. Make sure they understand the necessity of paying on time and the consequences for late payment. When these expectations are set at the beginning of your business relationship, they are easy to abide by.

When you make changes or adjustments to your invoice process, communicate those clearly, too. By being open with your clients and easy to communicate with, payments or consequences will never come as a shock.

Tip #4: Establish a Plan for Late Payments

Late payments will occur. It is unavoidable. However, the way you address late payments impacts your cash flow. Be as organized as possible when it comes to late payments. Communicate with customers regularly about when they are planning to pay, and if they are late, what the consequences are.

When you are organized and on top of your payment schedule, your client will follow suit. Continue to follow up with clients that have failed to pay, and do not shy away from legal action, if enough time passes.

Tip #5: Understand and Track Tour DSO (Day Sales Outstanding)

Your DSO calculates the average number of days it takes for clients to pay their invoices. This is a useful tool when monitoring the impact of your cash flow changes. The calculation is simple:

Day Sales Outstanding Formula

(Accounts Receivable/Total Number of Sales) x Number of days = DSO

The greater your DSO is, the longer it is taking clients to pay. That weakens your cash flow. The goal is to decrease your DSO, and hopefully, with these changes to your invoice process and the expectations you set for your clients, this is an achievable goal.

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Learning More About an Outsourced CFO for Easier Cash Flow Management

All of the tips above share a common thread: quality cash flow management can make a real difference for your business, but requires time and effort that business owners don't’ always have to spare.

That’s why strategically outsourcing this type of financial management can create real ROI for businesses in many different industries.

While it’s important to have a working knowledge of your company’s finances, you likely didn’t go into business to monitor your short-term cash flow.

Successful entrepreneurs know how to run their business, in part, because they’re passionate about the products or services they offer. If you connect with that statement, it might be ideal for you to hand the financial management reins over to an expert financial partner.

Turning to a financial partner or outsourced CFO takes the concerns of monitoring your long-term and short-term cash flow off your plate.

Look for a financial partner with the experience to assess your current cash flow status and optimize it for a streamlined, profitable business model. Doing so will allow you to concentrate on what you do best, and that’s running your business.

G-Squared can help you monitor your short-term cash flow. It is what matters most. We serve CEOs and entrepreneurs in Philadelphia, New York City and Washington D.C, and everywhere in between.

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Read More: 

7 Financial KPIs The Board Expects Every CEO To Know: Creating and tracking KPIs provides tangible information to the board. 

How to Instill Financial Discipline into Your Leadership Team: Your leadership should be well-equipped to make strategic, thoughtful decisions on behalf of your company. This article helps explain why. 

GAAP vs. Non-GAAP Financials: What is the difference between GAAP and non-GAAP financials? And more importantly, what does it mean for your business?