Why cash flow management is king

There’s an old saying in investing, supposedly coined in 1988 by then CEO of Volvo, Pehr G. Gyllenhammar: Cash is king. Referring to the lower risk holding of cash, instead of stocks, the phrase was particularly apposite at a time of stock market upheaval. For many small business owners, managing cash flow is the most important and challenging aspect of running their business. Holding too much cash means a business is inefficient, while not holding enough means the business could struggle to meet its commitments in the short term.

As many businesses are assessing their plans and forecasts in response to the Covid-19 pandemic, now is a perfect time to consider how your business manages cash flow.

What does cash flow management mean?

Cash flow management is the process businesses use to optimise how they use their money. For many small businesses, this can be as simple as ensuring that the business has enough money available to operate at any one time. With the constant inflow of cash from customers and outflow of payments to cover bills and pay suppliers set alongside a desire to grow and build the business, small business owners often struggle to optimise their cash management.

Let’s take an example - an e-commerce business needs to purchase, store and deliver the goods it sells through its website. It also needs to hold cash to take care of maintaining its website and paying any staff costs - its ongoing overheads. Let’s say the business’ sales are likely to be cyclical, revolving around major holidays. That means it needs to hold enough cash to pay for overheads during the quieter periods, as well as holding enough stock to distribute to customers when it receives orders. If we add to the mix an unforeseen bill, say a tax bill that was underestimated, or an unanticipated economic slowdown like we are seeing currently, the business needs to hold enough cash to deal with those circumstances too.

The importance of cash flow management

This is a simplified version of what small businesses need to consider to optimise their cash flow management. But managing liquidity is essential for small businesses to survive. If a business finds itself unable to pay invoices because of a lack of incoming cash, it risks failure. If a business is too liquid, it loses out through inefficiency, caused by holding on to too much cash. That same cash could and should be invested in creating value for the business.

Even a business which turns over a significant amount can find itself in difficulty if its leadership doesn’t actively manage cash flow. If the business cannot pay for suppliers, tax or other bills, on time, because of poor planning or a lack of liquidity, it won’t last longer than a few weeks or months. Regardless of how quickly and successfully the business grows and serves its customers, any such business can find itself in trouble. In fact, experts say rapid growth is one of the most common causes of death for small businesses.

How businesses keep control of their cash flow

Modern businesses use various methods to manage their cash flow. Here are some of the best tips your business could use to keep control over cash flow:

1. Master payables and receivables terms

Setting up favourable payables and receivables terms is one of the most important ways for a small business to gain an edge in cash flow management. One way to do this is to agree a quicker turnaround time for a customer to pay an invoice. To do this, business owners and CFOs need to get to know their customers. Customers with a personal relationship to the company are less likely to delay payment and can be relied upon to meet even favourable payment terms. Payables terms can be harder to negotiate, but many suppliers will agree to staggered payments if there’s a good reason for it. Again, this comes down to old-fashioned relationship management.

2. Cut costs

Another crucial way to manage cash flow is to cut costs. There are very few small businesses that could not withstand a 10% cut in costs without too much stress and disruption. This is an effective one-off measure to bring cash flow under control, but a regular cost assessment from leadership is also a great tool to bring cash flow under control.

3. Use a cash flow forecasting tool

There are numerous financial tools available for small businesses to support them in managing cash flow. Online accountancy platforms are becoming more and more common for business owners and CFOs. Different platforms dominate the market for accountancy software across different jurisdictions within the European Union. Some of the most popular among European businesses are Xero and QuickBooks but there are several smaller solutions which are favoured in different countries. Whichever tool you choose should integrate smoothly with your business bank account.

Most businesses use multiple cash management tools

One thing we always find surprising when speaking to business owners is that they are often using multiple tools, or their own bespoke set-up, to manage their cash flow. That means many business owners and CFOs are spending time setting up their own methods to track cash flow across various platforms - because traditional banks are not able to show the full picture of their cash flow.

That’s one of the reasons why we’re building one platform where businesses can track their incoming and outgoing payments, from supplier invoices to employee expenses. Soon, we’ll be adding direct integration with accounting platforms, to give our users the complete view of their business finances and allow them to manage cash flow through one simple, online platform.