Cash flow planning refers to the process of identifying and forecasting both incoming and outgoing cash for your business. It is typically done for both short-term horizons (less than a year) and long-term. The purpose of cash flow planning is to identify potential shortfalls and address them in a timely and responsible manner.
But even with proper planning many businesses can find themselves scrambling for cash at a time when they are least able to obtain it. These four suggestions may help you avoid foreseeable cash flow problems in your business.
Identify Your Main Cash Flow Drivers
Generally the main drivers of cash flow for any business are revenues, expenses, investments and money from lenders and investors. The precise combination of these sources and uses of cash will vary from business to business. When cash flow planning, consider identifying the main drivers of cash flow—both incoming and outgoing—for your business. For example:
- A manufacturing company that is aggressively expanding its operations may use enormous amounts of cash for capital investment. The cash may come from bonds or loans (debt financing) more than customer sales in the beginning.
- A software company may need significant amounts of cash to pay talented employees in engineering, business development and sales functions. The cash for this may come through financing in the form of share sales (equity financing).
- A retail company getting ready for the Christmas season may need to purchase significant amounts of inventory in the early fall to maximize sales in November and December. The cash for this may come from vendor financing or a revolving line of credit.
Keep an Eye on Inventory
Inventory represents one of the greatest challenges of cash flow planning. When your company buys inventory, it consumes cash. But that inventory may not generate cash again until it’s sold to a customer and that customer pays you. The cycle from “cash out to cash in” could take months depending on your business.
For this reason, you may want to consider properly monitoring and continually reviewing your inventory levels. If your inventory is too high, then you may be sucking cash out of your business unnecessarily; if it’s too low, then you may be forgoing sales that generate cash and profits. It’s a balancing act you need to master.
Be the Squeaky Wheel
When a client is having a problem paying their invoices, they may be making conscious choices as to which bills they will pay and which ones they won’t. Part of the rationale for choosing can include the expected response for non-payment. Put simply, if they think they can get away without paying you on time, they will. This could adversely affect your cash flow planning, and for that reason you may want to consider implementing policies that will discourage customers from paying late.
One way to do this is to be the squeaky wheel. You may not want to wait for customers to reach out to you when they can’t pay. Consider being proactive and communicative with your customers. Reaching out before an invoice payment is due and asking if everything is ok may help encourage them to pay sooner. Keeping it friendly may help your cause. Being proactive may help you gauge the possibility of a late payment so you can adjust your cash flow planning accordingly. Waiting until the payment is already late may render your cash plan obsolete.
You may want to consider using this form of proactive communication until the balance is paid in full.
Don’t Give Interest-Free Loans
When negotiating payment terms with your customers, you may want to ensure that your contracts include consequences for late payments. When a customer doesn’t pay you on time, you are in effect giving them a loan; they may be using your cash to either avoid interest costs or to generate additional sales. Either way they are making money with your money.
Are you being compensated for that? You may want to consider including a clause that states that late payments will accrue interest at a specific percentage rate per month. That rate can be high enough that you’d be comfortable letting them keep the money. Two percent per month for example is a rate used in many contracts because it’s high enough for you to be satisfied with the return if a customer should pay late, but too high for a customer to want to pay late.
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