Cash flow management system for SMEs

 

Cash flow management system for SMEs

Every business costs money to run. But how you cover your day-to-day operational costs can depend significantly on how big your business is. 

While large corporations often have access to multiple lines of credit and assets they can liquidise quickly to raise working capital, SMEs tend to be much more reliant on the revenue coming into the business to cover expenditure directly. This is what we mean by cash flow – the movement of money in and out of the business. 

It’s common for inflows and outflows of money not to be exactly in sync in any business. You might, for example, be used to waiting 30 days for invoices to be paid. But if a big quarterly tax or energy bill falls due right at the start of your own billing cycle, you might be left relying on money in the bank – or credit – to cover those liabilities. 

If you have neither, you find yourself defaulting. It doesn’t take much – an unforeseen expense, money you are owed not arriving on time, or the cost of debts racking up as you seek short term loans to pay your bills – for a single missed payment to trigger the slide towards insolvency. 

An estimated 50,000 SMEs go out of business every year in the UK citing cash flow problems as the cause of their downfall. Many of these are otherwise viable businesses that have no way to cover costs when revenue doesn’t arrive in time to pay bills. Once you’re on that slippery slope, it can be very hard to scramble back to safety and solvency. 

That’s why sound cash flow management is so imperative for small businesses. In this guide, we’ll cover exactly what cash flow management is and what it means to your business. And then we’ll outline strategies for staying in control. 

Understanding Cash Flow Management 

If cash flow can be defined in its simplest terms as the movement of money in and out of your business, then cash flow management is just as simply the tracking and control of cash flow. 

But as you might expect, in practice cash flow management is a little more complex than that. For a start, there are three different types of cash flow to consider: 

• Operating cash flow: This is what most people mean when they talk about cash flow – inflows of cash relating to the sales of goods and services, versus outflows relating to day-to-day operating costs (e.g. wages, money owed to suppliers, rent, utilities etc).  

• Financing cash flow: This describes any money coming into the business in the form of loans, investments and other types of credit/finance, and also what that might cost the business in terms of debt repayments etc. As mentioned, this is usually more relevant to larger businesses who generally have more financing options available to them. Although smaller businesses can often find cash flow problems spiralling when they turn to high-cost short-term loans to cover shortages in working capital. 

• Investing cash flow: Whereas operating and financing cash flow can be measured in short cycles (e.g month to month), investing cash flow takes a much longer-term view. This looks at the kind of outflows you might describe as investing in growth for your business – so purchasing assets, talent acquisition/development, product R&D, marketing spend etc – and then the returns you are getting. Investing cash flow has less of an immediate impact on the financial health of your business. But the ability to invest in growth at all is often contingent on strong and positive operating and financing cash flows. And poor investments that result in negative returns can drag down financial performance in the future. 

The goal of cash flow management is ultimately to make sure you have enough ready cash (liquidity) in the business to cover all liabilities as and when required. Cash flow management is therefore crucial to remaining solvent (the legal definition of insolvency being an inability to pay your debts).  

Effective cash flow management therefore depends on several things. It involves making sure that your business is earning enough money to cover all of its costs. But it also requires managing the timing of incomings so you always have cash available to make payments as required. Conversely, it involves keeping expenditure under control, and making sure you are not taking on more liabilities than you can cover in any given period of time. 

Five Strategies for Managing Cash Flow 

Managing cash flow requires a clear strategic approach. Here are five things to consider as part of a winning cash flow strategy. 

Cash flow planning and forecasting 

The first step to any effective strategy is mapping out a route to the goals you want to achieve. Managing cash flow is no different. It starts with gaining a clear view of all the money moving in and out of your business. To do this, you can make a cash flow forecast, which means projecting your expected inflows and outflows over a period of time (a year, say). 

From there, you can plot what you need the inflows to look like to ensure you always have cash available to pay bills (e.g. making sure accounts receivable are generally settled before accounts payable are due). This way, you can spot potential issues before they arise, and take action to remedy them. You can also make contingency plans to gain a buffer against unexpected expenses or hiccups in income. And, important for any business, you can see where there is the potential to invest surplus cash in growing your business. 

Cash flow monitoring 

Even the most accurate and thorough cash flow forecasts can’t hope to capture the many variables and unknowable’s that buffer a business through its day-to-day operations. Having a clear plan based on robust projections is important. But it’s equally important to then track actual cash flow closely. Without effective cash flow monitoring, it’s easy to veer off your intended course without realising. Monitoring also gives you the opportunity to make adjustments as and when required, whether that’s in response to unforeseen circumstances or to take advantage of opportunities to improve on your original strategy that might present themselves. 

Cash flow monitoring is more effective the more regularly you analyse the figures. These days, modern accounting software makes this easy. By managing your accounts receivable and payable digitally, not only can you take advantage of automation to make processes faster and more efficient, you can also run analytics more or less in real time to always have clear insight into cash flow performance and trends. 

Effective invoicing & collections 

The single biggest cash flow challenge many small businesses face is managing when they get paid. Certainly for B2B suppliers and service providers, the convention of lengthy payment terms on invoices means there is often a significant gap between goods and services being delivered and payment being received.  

On top of that, there’s no guarantee that invoices will be paid when you expect them to be. Half of all SMEs in the UK – some 2.8 million businesses – report invoices being paid late (or not at all) on a regular basis.  

Trusting that you will receive money you are owed when you expect it is critical to effective cash flow management. While the risk of late payments is unlikely to disappear completely without tougher regulatory sanctions being introduced, small businesses can take the following steps to make their accounts receivable operations as watertight as possible: 

• Do your due diligence on prospective new clients and customers. Credit and other background checks help you establish that anyone you plan to do business with is a) reputable and b) in a healthy financial position themselves. Prospects with poor credit history are more liklely to be poor payers. 

• Set out your expectations around payment terms clearly from the beginning of any new client relationship. Stand your ground on insisting on payment windows that are as short as possible, and which suit your cash flow needs. The recognised standard (and the statutory default if no terms are agreed) is 30 days. While many larger businesses still try to impose longer terms, it is becoming less common and most will accept a 30 day maximum. Whatever is agreed, set out the terms clearly in a contract – including arrangements and penalties if invoices are not paid on time. 

• Familiarise yourself with every clients’ accounts payable processes. Businesses work in different ways. Some of the most common excuses for an invoice not being paid on time include things like it being sent to the wrong department, or not quoting a purchase order number correctly. 

• Send your invoices out promptly. The sooner and more efficiently you send out an invoice, the sooner you will receive payment. If you are being paid in arrears, you should ideally issue an invoice as soon as every order is fulfilled. Accounting software with automated invoicing tools is a huge help in keeping on top of this. 

• Check every invoice you send for mistakes. Again, incorrect invoices are a common reason given for late payments. Automated invoicing software helps to improve accuracy, too. 

• Track payments carefully. As soon as a payment is overdue, you should issue a reminder, followed by a warning of your intention to take action if payment still doesn’t arrive. By law, you are entitled to charge a late payment penalty plus interest on every overdue invoice.  

Sales growth strategies 

As well as making sure you have money coming into your business on time to meet your financial liabilities, good cash flow management also involves ensuring that you have enough money coming in. And that doesn’t mean settling for ‘just enough’.  

No business owner will ever turn down an opportunity to increase revenues and margins. But from a cash flow management perspective, actively looking for ways to boost income does two important things. One, it helps to provide a buffer against unforeseen cost increases. And two, it gives you capital to invest in your business. 

Growth bolsters your cash flow by widening the gap between inflows and outflows in the former’s favour. However, if your aim is to reinvest increased revenues back into the business, you have to consider your investing cash flow. Putting too much in, too fast, with returns that won’t be realised for quite some time, can leave your operating cash flow vulnerable. 

Cost management & budgeting 

Invoice management and sales growth strategies are about the inflow of money into your business. Effective cash flow management has to consider money going out of your business, too. This centres around keeping a tight lid on expenditure. And that starts with drawing up and working to a budget. 

While a cash flow forecast maps out an expected schedule of money coming in and out of your business, a budget takes gross revenues plus financing from other sources (e.g. loans, external investment), and from there works out what the business can afford to spend. 

Business costs are split into two main categories, fixed and variable. Fixed costs are known and stable for the duration of a budgeting period, and include things like rent, utilities (although things like electricity might vary slightly), contracted services and labour (even if you plan to give staff a pay rise or recruit more people, this can be anticipated as a ‘fixed’ cost). 

Variable costs include expenses that depend either on prices set elsewhere or variable volumes. Stock, raw materials and other goods purchased from suppliers are good examples of variable costs.  

A budget is essential to effective cash flow management because it tells you in black and white if you can cover your expenses or not. If not, then you know you need to cuts costs (as well as increase sales if possible) to stay afloat. And because some costs vary, you need to keep a close eye on them to ensure expenditure doesn’t spiral beyond what you can afford. This is where tried and tested accountancy practices like profit and loss reports and cash flow statements show their value. 

Final Thoughts on Cash Flow Management 

In this guide, we’ve covered the essentials of what cash flow management is, why it’s so important for SMEs, and five key strategies for getting it right.  

Once you delve into the practicalities of controlling cash flow for your business, there is plenty more to explore. This includes things like tax planning to ensure you can always pay Revenue on time to avoid penalties, but also to avoid paying more in tax than you have to pay. And also the pros and cons of taking on debt to cover working capital, which can sometimes be necessary and even advantageous to cover short-term needs, but which can saddle you with extra expenses that sabotage your cash flow further down the line if you don’t approach it prudently. 

With a wealth of experience in helping small business owners thrive, our team of financial management and accounting professionals are the perfect partner to help you get to grips with cash flow management. We understand the unique challenges faced by SMEs, and we work closely with you to create customised solutions that align with your specific needs and goals. 

Cash flow management system for SMEs