How to Optimize Your Business’s Cash Flow
Q: What are the important factors to consider when optimizing my business’s cash management?
A: It requires diligence and the right set of budgeting tools and projections to optimize cash flow, which is often more critical to the growth of a business than profits.
Determine Your Business’s Current Cash Position
Short-term cash flow projections, such as those that are weekly or monthly, and longer term projections that look at a company’s growth over one year, three years, or even five years are key to determining a business’s current cash position. This is especially true if a business is experiencing fast growth or weathering tough times. Savvy business owners review past cash flow statements to glean wisdom on past decision-making and trade-offs made, among other notable trends, to be able to make more accurate projections and maneuver as much cash out of their balance sheets as they possibly can.
Inventory and accounts receivable (credit accounts, credit you extend to customers) are often significant drains on a business’s cash. For example, once you understand if you’re running out of inventory too quickly or if your customers are taking too long to clean up their accounts, you can adjust your terms accordingly to have more cash coming in to the business. This might mean asking for cash upfront for new customers, offering shorter payment terms, or increasing late fees.
There are some handy tools out there to facilitate this approach, such as lockbox systems to collect payments. Customers wire or mail to a lockbox, and your bank can then sweep funds in to an interest-bearing account.
Another key to better cash management: Focus on when a business is paying its suppliers and vendors to optimize cash flow. By asking for longer terms and paying on and not before the day the bill is due, a manager is maximizing cash on hand. Lines of credit can be paid down with the available cash to save on interest fees.
Understanding the Nuances of Cash Management
Another key factor for new and established companies alike is for business owners to always improve their understanding of the nuances of cash management. Working capital, or operating cash flow, is generated by sales of your product or services and is usually the easiest to understand and control for most business owners. But beyond working capital, there is also “investing cash flow,” which is generated from internal fixed assets, such as investments in plants and equipment or other fixed assets, nonrecurring gains or losses, and “financing cash flow,” which is the cash that moves to and from external sources such as lenders, investors, and shareholders.
Financial statements provide the information and insights that can lead to increased spare cash, but it remains crucial that business owners avoid large risks -- so don’t invest all your reserves in the stocks your buddies tell you about over beers or the risky stocks peddled by brokers or advisors who may be working on commission-based sales.
Make Your Available Cash Work for You
And that brings us to the key question within the question: How can a business owner or manager best make available cash work for the company? To answer this, you need to focus on interest rates paid versus the interest that can be earned on investments. It may not sound like a big epiphany, but many business owners don’t focus on paying down their credit lines to avoid higher rates and fees and instead take available cash and invest it at lower rates. Pay off high-interest-bearing debts first.
Once the balance sheet is in order and there is enough cash available to handle normal fluctuations in transaction volumes, you can consider investing the cash in sweep accounts, end-of-day sweep accounts, and lockbox accounts. More predictable cash flow and a stable cash position allows a business manager to look to investments, especially if there is a pending increase in a line of credit or a cash infusion from angel investors on the horizon.
Optimizing your cash management doesn’t have to be complicated. Simply put, always maximize cash flow and allocate cash with the idea of improving your company’s stability. The key factors to support that approach involve generating the following data.
- Up-to-date knowledge of when, where, and how the business’s cash needs arise
- Strong sources for meeting any additional cash needs via good relationships with a banker and other creditors
Remember: Carefully controlling available cash on hand is one of the biggest assets an established business can have.
