Improving cash flow

Author: Jim Riley Last updated: Sunday 23 September, 2012

Improving cash flow

The keys to the ability of a business to handle cash flow problems are:

Have a reliable cash flow forecasting system
Actively manage working capital
Choose the right sources of finance for the business needs

Good cash flow forecasting is at the heart of cash flow management. The key is having good information and using it! A good cash flow forecast:

Is updated regularly
Makes sensible assumptions
Allows for unexpected changes
Is reviewed regularly by senior management

Working capital management focuses on:

Striking the right balance between offering customers credit and ensuring that they pay on time
Holding an appropriate level of stocks in the business
Managing relationships with suppliers so that the maximum amount of trade credit can be obtained without damaging supplies to the business

Managing Debtors (credit control)

This isn’t easy. Credit control covers areas such as

Policies on how much credit to give and repayment terms and conditions
Measures to control doubtful debtors (chasing, threatening legal action etc)
Credit checking (only allowing credit to customers who can afford to pay!
Selling off debts to debt factors
Cash discounts and other incentives for prompt payment
Improved record keeping – e.g. accurate and timely invoicing

One area you should be aware of is factoring. This involves the selling of debtors (money owned to the business) to a third party. This generates cash and it guarantees the firm a percentage of money owed to it. The downside to factoring is that it reduces income and profit margin made on sales. The costs involved in factoring can be high!

Managing Suppliers (trade credit)

Suppliers are important sources of finance for a business and key part of managing cash flow. “Trade credit” refers to amounts owed to suppliers for goods supplied on credit and not yet paid for. Delaying payment means that the business retains cash longer.

However, by delaying payment, the business has to be careful not to damage its credit reputation and rating. Trade creditors are seen (wrongly) as a “free” source of capital. Some firms habitually delay payment to creditors in order to enhance their cash flow - a short sighted policy which also raises ethical issues.

Managing Stocks (stock control)

Stock refers to goods purchased and awaiting use or produced and awaiting sale. Stocks take the form of raw materials, work-in-progress and finished goods.

Stockholding is costly and therefore it is sound business to:

keep smaller balances (just in time stocks)
computerise ordering to improve efficiency
improve stock control

This will cut down the spending on stock but may leave the business vulnerable to “stock-out” (i.e. no stocks available to meet demand – which is bad news!)