Never take your eyes off the cash flow because it's the lifeblood of business."
- Sir Richard Branson.
If a business has a positive cash flow, it means that there is more money coming into the organisation than going out. Rapidly growing organisations tend to have more cash to buy stocks, hire employees, etc. Therefore, it is essential to have a look at the organisation's cash and cash flow. Let's find out what cash flow is and what the methods are for improving cash flow and profits.
What financial decisions should be made to improve cash flow and profits?
There is nothing that can unsettle a business quicker than inadequate cash flow. Even though the business might have potential, a convincing product line, and a great reputation, if it does not have the cash it requires to operate then it will come to a halt, or even have to stop trading.
Cash flow is the movement of money coming in and going out of a business. Cash obtained is the inflows, and cash spent is the outflows. Profit is the money left from a business activity after expenses, costs, etc.
It is therefore very important to make decisions that will stabilise cash flow. Here are some areas to consider:
Design the product in a way that will bring healthy profit margins
At times products/services are priced without assessing what factors it might take to sell them with a profit. Factors such as the time needed in the delivery of the service or production, designing, service, business overheads such as insurance, subscription of software, taxes, etc are all need to be taken into account.
Receiving payment in an expected way lowers the risk of having to chase invoices
On occasions, payments can be postponed because of mediocre organisation and business planning. This can be avoided by creating well-defined policies and monitoring projects. This should be done by structuring services that need to be paid upfront, having transparent limits for project payments, for instance, 'payable in 30 days', finishing the work on time and keeping the client up to date about project status.
Set a transparent, coherent, and systematic way of managing the financials
At times, cash flow issues appear out of the blue as the business owners do not have precise and up-to-date information on their finances. This issue can be eliminated by creating a transparent and systematic method for managing finances.
Methods of improving cash flow
There are various methods of improving cash flow. Some of the popular methods businesses may use include:
Getting products to the market quickly,
Debt factoring,
Trying to get paid as soon as possible,
Trying to keep raw material stock to a minimum,
Leasing equipment instead of buying it.
What are the methods of improving cash flow and profits?
Let's now take a look at how businesses can improve their cash flow and profits.
Methods for improving cash flow
Getting products to the market quickly if possible. This is because the quicker a product reaches the consumer, the quicker payments will be received. Production and distribution should be as efficient as possible.
Getting paid as soon as possible with the help of a 'cash on delivery' option, for instance, will improve cash flow. The business can also promote early payments by providing incentives such as discounts for timely payments.
Another possibility could be debt factoring, the business could accelerate payments by factoring money due.
Debt factoring is a short-term and external source of finance for an organisation. With this, an organisation can receive cash when it sells its accounts receivable (outstanding sales invoices) to a third party at a discount.
The business can keep its stock of raw materials to a minimum. Efficient stock management, such as 'just-in-time' (JIT), can be applied. This means the business won't have to pay for stocks prior to its need.
The business can also lease equipment or rent a building instead of buying, avoiding high purchase costs. It will also reserve the capital which can be invested elsewhere.
Methods for improving profitability
It is essential to calculate the profitability of upcoming projects for the financial health of the business with the help of metrics, such as net present value (NPV), internal rate of return (IRR), and the payback period.
Evaluating the income statement to observe the expenses. This way the business can eliminate any unnecessary expenses, conduct an audit of expenses, and trim any process inefficiencies.
It is vital to create a budget and follow it strictly. Understand budgeting timelines, methods, and financial statements so that a budget to achieve profitability and efficiency.
Conducting market research can facilitate learning about customer mindsets (current and potential).
If a business offers a range of products, it can also sell two or more products together at a lower price.
What are the ways to improve cash inflow?
Now that we understand the issues with cash flow, let's take a look at how it can be improved.
Conduct checks for customer credit
If a customer does not want to make a payment in cash, it is necessary to do a credit check prior to signing them up.
In the case of poor credit, it might be safe to suppose that the payments will not be received on time.
As eager as the business might be to make a sale, delayed payments will affect cash flow. If the business chooses to sell regardless of poor credit, it must be sure to set a higher interest rate.
Create a buying cooperative
A business can search for other companies who might want to pool their cash, in order to negotiate for lower prices from suppliers, who often offer large discounts to big companies who purchase in bulk.
Enhance the inventory
The business can do an inventory check and make a list of those products that might not be moving at similar speeds as other products. Having excess inventory may tie up a great amount of cash that can affect cash flow.
Send out invoices promptly
Sending out invoices promptly will lead to receivables coming in faster. However, it is essential to understand the basics of writing a good invoice, one which is easy to read, with clearly stated terms and conditions, and instructions about the forms of payment accepted. This will help with the faster receipt of receivables.
What are the difficulties with improving cash flow and profit?
Some of the issues with improving cash flow are listed below:
Costly borrowing
Debt payment can lead to cash flow issues when a business is not able to afford to finance itself. Loans taken by the business and credit cards with increasing interest rates may take up a great portion of revenue.
In certain situations, payment way-outs, such as supplier financing, can support a business to enhance its cash flow and prevent extra debt.
Diminishing sales or profit margins
The sale of products/services at low prices can lead to diminishing profit margins. The same issues can appear when sales teams provide discounts that may lower profit margins. Usually, this affects small businesses that do not have an efficiently developed pricing strategy. Evaluating expenses and prices can assist small businesses in understanding if they need to adjust prices or give discounts on products/services with lower profit margins.
Inaccurate predictions or bookkeeping exercises
It can be comparatively easy to keep track of cash flow and predict sales. However, with the growth of the business, there may be a stage where cash management becomes complicated.
Seasonal fluctuations in demand
Several kinds of business experience changes in the demand for seasonal products. If they do not take these fluctuations into account it may result in cash flow problems. Accurate sales predictions and cash flow forecasts can help businesses plan for fluctuations in the demand for seasonal products.
Businesses can improve profitability by:
Setting correct prices
Setting prices is one of the most significant decisions to be made. The way a business sets prices can determine future success. There is always a concern when setting prices too high. If the cost is higher than prices set by rivals, there is a chance of turning away the target market.
Nonetheless, if prices are set too low it may mean that the business spends more on production than it will be able to generate from sales. Therefore, profit margins should be carefully considered. On the other hand, if consumers like the quality of the products, they might be willing to pay more for them.
Reconsidering the cost of overheads
There are certain things that a business needs to operate and survive. But there may be some overestimation of needs in certain areas.
A business might not need a 4000 square foot office for a couple of employees or it might not need to buy certain equipment that merely adds marginal value to the end product.
An organisation can manage and improve its cash flow by implementing appropriate methods and approaches. It should evaluate all the possible options and choose the most suitable forms to increase its cash flows, not just in the short term but also in the long term.
Cash Flow Improvement - Key takeaways
There is nothing that can unsettle a business quicker than inadequate cash flow. Even though the business might have good prospects in the future, a convincing product line, and a great reputation, if it does not have the cash it requires to operate then it will come to a halt or might even have to close.
Methods to improve cash flow include: getting products to market in a short time, cash on delivery, debt factoring, lower stocks of raw materials and leasing instead of buying equipment/building, etc.
Ways to improve profitability include: calculating the profitability of upcoming projects, evaluating income statements, creating a budget, conducting market research, etc.
Difficulties faced with improving cash flow include: costly borrowing, decreasing sales and profit margins, inaccurate predictions, and seasonal fluctuations
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