The skinny on cash flow management

Cash is the lifeblood of most businesses, and cash flow management is an essential skill to learn to ensure your business stays afloat. Proper cash management can help companies invest and grow, have strong relationships with vendors, prepare for emergencies, and maintain a solid business credit rating, among other benefits. Poor cash management can have the opposite effect: It can leave businesses struggling to pay vendors, creditors, and employees.

What is cash flow management? In a nutshell, cash flow management involves monitoring the movement of cash into and out of a business, and taking steps to optimize it.

To manage cash flow, it’s essential to accurately track where, when, why, and how much cash comes in and out of the business. Most businesses prepare cash flow statements, or documents detailing inflows and outflows of cash over a given accounting period, on a regular basis. Public companies are required to issue cash flow statements as part of their annual financial reporting, but even small companies can benefit from preparing them.

Generally speaking, businesses track three main types of cash flows:

• Cash flow from operations (CFO): cash obtained from selling goods or services, and cash spent on producing goods or services, such as payroll, rent, machinery, and the like
• Cash flow from investing (CFI): cash gained or lost from investment activities, such as buying or selling assets or securities
• Cash flow from financing (CFF): cash inflows or outflows related to a company’s financing activities (such as its debt, equity, or dividends)

Forecasting and optimizing cash flow: But tracking cash flow is only the first step to managing it. Once businesses have the data they need, they can then forecast their cash flow for the near future. (Some experts recommend that companies forecast at least three months, six months, and a year out.) They can predict whether they’ll have excess cash on hand or will face cash flow problems. Companies can also plan for different scenarios, such as losing a major client, to help identify risks and minimize the effect on their cash flows.

Businesses can use their data to optimize their cash flow. If they have a surplus of cash coming in, they may put some aside as a buffer against hard times or invest it back into the business. Or, if they anticipate being short on cash, they can take steps to free it up. They can examine their operating expenses to find areas that can be trimmed. (One strategy is to identify the business’s five largest expenses and brainstorm ways to reduce them.)

Streamlining AP and AR: Another key aspect of cash flow management is optimizing accounts payable (AP) and accounts receivable (AR). Companies can take steps to assure they’re paid in a timely fashion, such as issuing invoices when goods and services are rendered, requiring payment within a specific time frame, and offering discounts for early payments, and levying penalties for late payments. At the same time, they can negotiate better payment terms with vendors or creditors, perhaps asking to pay over a longer period of time or at more optimal times during their business cycles. Companies can also automate their AP and AR processes to make them smoother and more standardized.