Standard accounting software packages can help businesses foresee bottlenecks and timing issues, and gives enough time to take action to resolve these difficulties.
Great cash flow management, however, is more than running an accounting software package. The following steps can help any business ensure it is managing cash flow effectively.
Best practice in cash flow management
According to Craig West, CEO of business strategy firm Succession Plus, most businesses don't forecast cash flow. "They may have experienced an extended time when cash flow has not been a problem so they drop the discipline of projecting cash," he says. "Then something happens – for example a financial shock or a client goes bad - and suddenly cash flow is a problem."
It is relatively easy to predict cash outflows, as companies know when they have regular payments such as tax, salaries and operational costs. Inflows are much less certain, as it's difficult to know exactly when customers are going to pay. "Overdue payments are the biggest risk to small and medium business cash flow," says Ennio Alberici, Finance Director for Sage Software Australia.
Craig West suggests some practices for managing late payments. “Have an automated system in place that follows up late payments, do credit checks on all new clients no matter how good they look, and establish a relationship with a bank that understands your business model and your cash flows," he says.
Good technology and systems are key to improving and managing cash flow. This includes receiving timely information from an integrated digital banking platform. “Best practice for billing means using cloud-based software and electronic payment solutions, which provide invoicing tools that save time and optimise cash flow," says Alberici. "They allow you to offer multiple forms of payment and quickly follow up with clients by giving business owners easy access to invoice records and reports."
Planning around larger cash inflows and streamlining invoicing processes also help to smooth cash flows and prevent bottlenecks and shortfalls.
Best practice for running a cash flow forecast
Running a cash flow forecast doesn't have to be complex or time-consuming. A cash flow forecast can be mapped out in just 30 minutes, says Kerry Dutton, Founder of online bookkeeping business Think180degrees.
"It's easy to start looking in the wrong places, such as manuals, external data analysis and complicated templates. The main purpose of your cash flow forecast is to provide a forward thinking perspective you can use to plan ahead," she says. “Use a cash flow forecast to aim the business towards success and give the business owner clarity, financial focus and balance."
Here are Dutton's three steps for implementing best practice cash flow forecasting:
1. Just begin
Start, as something is better than nothing. Begin with what you know and review the forecast at least every six to 12 months.
2. Use good business data
Industry data and competitive analysis is often backward looking and of little use when it comes to cash flow forecasting.
It may be appropriate to use historical assumptions where these are relevant to predict a likely future outcome. For example, the most reliable source of historical evidence in a business is key performance metrics, such as average client conversion rates and growth rate of new clients per month.
3. Apply 'what if' scenarios
The basis of cash flow forecasting is to model alternative scenarios that could take place during the forecast timeframe. It is tempting to pick the rosiest scenario and hope that this will eventuate. But a more realistic approach would evaluate less beneficial scenarios too, thus helping the business foresee and develop strategies for managing "worst case" cash flow problems. It is also important to question growth assumptions, and consider what would happen if certain services didn't perform as expected.
For example, suppose you forecast your business to grow from $300,000 to $1 million, but a huge proportion of this is reliant on the success of a first online program. If that program falls short of expectations, the forecast will be wrong. Launching an online program for the first time is a risky business, since there is typically little historical evidence on which to rely. So a prudent forecast might apply a discount factor to the ideal outcome to recognise the risk that sales might disappoint or the program develop problems.
Great cash flow management isn't a quick fix. It needs discipline and attention to detail. Cash flow needs to be reviewed at least monthly to help the business move through any money limitations.
- Don't undercharge upfront: revalue products by breaking down all the included value and the time spent on each component.
- Love the numbers: create a monthly cash flow plan and set three goals to improve cash flow in 90 days.
- Overcome limitations: ensure business processes are appropriate. For example, don't provide a service prior to a deposit payment.