Everything you need to know about small business cash flow management

Cash flow management is essential to the stability and growth of your business. Actively manage and optimize the way money comes in and out of your accounts, and you’ll never be caught out. 

Conversely, poor cash management can quickly lead to liquidity problems and jeopardize your business. No cash, no business.

In this article, we offer you a comprehensive guide to good cash management, helping you to master the key tools, methods and concepts to keep cash flowing smoothly.

What is cash flow management?

Cash is the money available to a company at a given moment. It includes funds at hand, bank deposits, and short-term investments. Unlike profitability, which measures the profits generated by the business, cash flow measures a company's ability to settle its short-term financial obligations, such as salaries or supplier payments.

Cash flow management, therefore, is the process and strategy used to put these funds to best use, and ensure there’s always money available when you need it. 

From an accounting point of view, cash flow is the difference between working capital (WC) and working capital requirements (WCR):

Net cash = WC - WCR

To fully understand this formula, it is important to define each component:

• Working capital (C): This is the total financial resources available to a company for its day-to-day operations.
• Working Capital Requirement (WCR): This refers to the cash needed to finance the business in the medium term. It is calculated by subtracting current liabilities (short-term debts) from current assets (receivables, inventories).

Good cash management aims to maintain a positive cash balance to ensure that the company can meet its obligations at all times.

Why cash management is vital for small businesses

Effective cash management helps to:

• Keep you solvent. At a fundamental level, you need to be able to honour debts and avoid late payments.
• Maintain room to maneuver. With available cash, you can seize investment opportunities and deal with unforeseen expenses.
• Preventing liquidity crises. A well managed cash position anticipates periods when cash may be short.
• Reduce financial risks. Fluctuations in interest rates or outstanding receivables are better managed with a stable cash position.

Key elements of cash flow management

Monitoring cash flow is based on a number of key indicators, often referred to as KPIs (Key Performance Indicators). To manage cash flow effectively, it’s important to understand its components:

• Active cash: This is cash on hand, such as money in the bank or short-term investments.
• Passive cash: This is short-term debt, such as supplier credit or bank overdrafts.
• Net cash: This indicator measures the difference between available cash (active cash) and short-term debts (passive cash). 

Here are three common ways of calculating net cash:

1. Net cash = Working Capital (WC) - Working Capital Requirement (WCR).
2. Net cash = Cash at bank and in hand - Short-term borrowings.
3. Net cash = Cash assets - Cash liabilities.

A positive cash balance means that the company is able to cover its financial commitments. If the balance is negative, you’ll need to find short-term financing to make up the shortfall.

Other useful concepts

In addition to cash flow, here are some other important indicators:
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• Net consumption: This indicator represents the difference between monthly disbursements and receipts. It shows whether the cash position is in surplus (in the green) or in deficit (in the red).
  
  
• Cash burn: This term refers to the amount of money spent each month to cover company costs. It is used to assess how quickly a company ‘burns through’ its cash.
  
  
• Working capital (WC) and working capital requirement (WCR): These two indicators measure the resources needed to finance the business in the short term. Changes in WCR can increase rapidly in a fast-growing company, which can temporarily weigh on cash flow if sales do not immediately cover the additional costs.

Working capital management is particularly crucial for small businesses. Poor control can quickly deplete available cash and put the brakes on a company's growth. Optimizing working capital frees up financial resources and avoids cash flow pressures.

How can you improve your cash management?

Without good processes, cash management can quickly become complex. Here are a few best practices to follow for effective management:

• Use treasury software: Unlike Excel, these tools automate processes and provide a complete view of financial flows, reducing the risk of errors.
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• Daily monitoring: Real-time monitoring of financial flows, automation of bank data, forecasts based on historical data and alerts in the event of critical thresholds enable proactive and effective cash management.
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• Anticipate cash needs: Drawing up forecasts at the start of the financial year and adjusting them regularly gives you better control over your cash flow. It is advisable to plan for several scenarios to test the robustness of cash flow.
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• Speed up customer payments: Offer discounts to encourage prompt payment or set up automatic reminders. The sooner you get paid, the sooner you’ll have cash available for your own needs.
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• Use short-term financing: Factoring and receivables financing are both useful tools to receive owed cash faster. Even better, Defacto lets you open a line of credit against outstanding customer payments, with low fees and no unnecessary admin.  
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• Optimize your inventory: Stock represents a significant cost. It is therefore crucial to limit the volume of stock and maintain a high stock turnover to free up liquidity. Any items that sit in storage unsold for long periods will directly harm your cash flow.
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• Negotiate longer payment terms with your suppliers: Extending payment terms can help you balance your cash flow.
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• Reduce working capital requirements (WCR): This can be done by optimizing stock management or speeding up the collection of receivables, as seen above.

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The first step is to get serious about cash flow. Make a fast cash conversion cycle a key business goal, and put time and effort into keeping it short and efficient. 

Every SMB needs a cash management plan

A good cash flow forecast tracks cash inflows and outflows over a given period, usually several months. It includes:

• Inflows (cash receipts): Sales, capital injections, subsidies, etc.
• Outflows (disbursements): Purchases, expenses, salaries, taxes, repayments, etc.

By updating it daily, you can anticipate periods when cash flow will be tight and plan your response. This could include seeking external financing or optimizing your cash receipts.

In conclusion

Cash management is essential to the survival and growth of a business. Good management allows you to anticipate financial needs, avoid unforeseen events and ensure lasting stability. 

This can be achieved through appropriate rapid financing options. Defacto, for example, can provide tailor-made solutions to maintain healthy cash flow and manage short-term needs. 

If you need access to fast, flexible working capital financing, talk to us.