10 cash flow missteps your business may be making and how to avoid them
Positive cash flows is the lifeblood of every organization. The definition of a growing and successful business is one that is able to generate net positive cash flows on a consistent basis. Even with the best profit margins, if your company is not generating positive cash flows, that’s a huge red flag. A company that is experiencing cash flow challenges could be making one or more of the following missteps:
Not forecasting regularly- Management should create short term (weekly, monthly) and long term (quarterly, annually) cash flow forecasts. This helps them to proactively identify future cash shortages or surpluses and to plan accordingly. If there are anticipated cash shortages, management may need to consider securing a line of credit or transferring funds from the operating reserves. Alternatively, if a cash surplus is forecasted, funds could be moved to operating reserves via some sort of short term investment such as treasury bills.
Failure to leverage financial metrics & Key Performance Indicators (KPIs): Management should regularly monitor cash flow and liquidity ratios to ensure they remain comparable to industry averages and within the company’s target range. These ratios include the quick ratio, cash conversion cycle, and working capital ratio. Staying on top of these metrics ensures that red flags are identified and addressed before they become much bigger problems.
Not focusing enough on accounts receivable & payables turnover: The goal should always be to increase the accounts receivable turnover rate through such measures as incentivizing early customer payments by offering small discounts, ensuring that invoices are accurate to minimize delays in payment due to inaccuracies and automating invoicing to ensure timely billing. Additionally management should seek to prudently extend payment terms for vendors to delay outgoing cash flow. Management should also consider reviewing vendor payment terms at least annually and seek to renegotiate extended payment terms.
Ineffective debt management: Management should review loan contract terms and consider refinancing high interest loans. Additionally, they should utilize ratio analysis to measure and monitor whether the company is adequately leveraged. In other words not carrying too much debts.
Not performing fixed asset purchase vs lease analysis : Asset leasing results in a much smaller outlay of cash upfront when compared to purchasing. Accordingly, management should consider exploring the leasing option to acquire much needed machinery and equipment for their companies. In this way freeing cash flow to be used for other urgent needs.
Ignoring best practices for cash flow risk management: Management should consider taking out credit insurance to mitigate the risk of material debtor balances defaulting on payment. Additionally, they should implement supply chain diversification to minimize the risks of supplier chain disruptions. Additionally, management should consider creating an operating cash reserve to minimize disruptions from future uncertainties.
Ignoring the implementation of robust internal controls surrounding cash management: Management should implement robust internal controls to safeguard safeguard cash. For eg. the use of Positive Pay to prevent the cashing of unauthorized checks. Additionally, there should be proper segregation of duties surrounding the cash function and proper review and approval of vendor invoices.
Failure to perform regular profitability reviews: Management should perform regular profitability reviews of all areas of the business(including product/service line, locations and customer segments). They should consider eliminating or revamping low profit-margin segments, products/service lines, while ensuring the most profitable activities are adequately funded.
Not conducting Scenario Planning: Management should leverage scenario planning (through financial modeling) to assess the cash flow implications of changes in certain key variables. For eg. hiring additional staffing, increased raw material costs or a significant decline in revenues. This allows management to proactively plan for cash shortages and ensure adequate liquidity on a consistent basis.
Not fostering a culture of cash flow optimization: Management should create a culture that encourages or rewards employees who seek to optimize cash flow. They should provide tools and training to foster a mindset of continuous improvement to the organization’s cash flow position.
As part of our CFO advisory Service offering, we assist small businesses and nonprofits with developing and implementing effective cash flow management strategies. Should you need any assistance in this area, please feel free to book a free consultation below or call (813) 489-0295.