Cash flow management

By Mark E. Battersby

Cash flow is the lifeblood of every business. In fact, according to a recent U.S. Bank study, poor cash flow management causes 82 percent of U.S. business failures. Although seemingly counterintuitive, many experts advise putting cash flow management before profits.

While profits are how a fabrication business survives, a failure to manage the operation’s cash flow can mean running into problems that one profitable accounting period might not be able to offset. Another study, this one by Intuit, revealed that 61 percent of small businesses around the world struggle with cash flow and 32 percent are unable to pay vendors, pay back pending loans, or pay themselves or their employees due to cash flow issues.

Cash flow management 101

In essence, cash flow is nothing more than the movement of money in and out of the business. Cash flows into the business from sales of goods, products or services. Money flows out of the business for supplies, raw materials, overhead and salaries in the normal course of business.  

An adequate cash flow means a steady flow of money into the business in time to be used to pay those bills. How well the fabricating professional manages the operation’s cash flow can have a significant impact on the bottom-line profits of the business.

Often, an operation’s cash inflows will lag behind its cash outflows, which leaves the business short of money. This shortage, or cash flow gap, represents an excessive outflow of cash that may not be covered by a cash inflow for weeks, months or even years.

Properly managing the operation’s cash flow allows that cash flow gap to be narrowed or closed completely before it reaches the crisis stage. This is usually accomplished by examining the different items that affect the operation’s cash flow—and looking at the various components that directly affect cash flow. This analysis can answer important questions such as the following:

• How much cash does the business have?
• How much cash does the business need to operate and when is it needed?
• Where does the business get its cash and where does it spend it?
• How do the operation’s income and expenses affect the amount of cash needed to operate the business?

Controlling inflow

In a perfect world, there would be a cash inflow, usually from a cash sale, every time there is an outflow of cash. Unfortunately, this occurs very rarely in our imperfect business world, thus the need to manage the cash inflows and outflows of the business.

Obviously, accelerating cash inflows improves overall cash flow. After all, the quicker cash can be collected, the faster the business can spend it. Put another way, accelerating cash flow allows a business to pay its own bills and obligations on time or even earlier than required. It may also allow the business to take advantage of trade discounts offered by suppliers.

Controlling outflow

Outflows are the movement of money out of the business, usually as the result of paying expenses. A manufacturing business’s biggest outflow most likely involves the purchase of raw materials and other components needed for the manufacturing process. If the business involves reselling goods, the largest outflow will most likely be for the purchase of inventory. Purchasing fixed assets, paying back loans and paying bills are all cash outflows.

Fabricators can regain control over their operation’s finances by adopting best practices and proper tools. A good first step involves how the operation pays its bills. An important key to improving an operation’s cash flow can be as simple as delaying all outflows of cash as long as possible. Naturally, the operation must meet its outflow obligations on time, but delaying cash outflows makes it possible to maximize the benefits of each dollar in the operation’s own cash flow.  

Many credit cards have a cash back bonus program. Even if the program offers only 1 percent cash back, that could equate to a sizable monthly amount for many businesses. Of course, because credit cards tend to have a higher interest rate, they should only be used if the balance can be quickly paid off in full.

Improving invoicing

Improving the invoicing process is another key step in cash flow management. A business can adopt incentive strategies to be paid faster. A business enjoying a 10 percent gross margin that offers a 2 percent rebate in exchange for early payments might not be appropriate. Giving away small extra services, on the other hand, might work. Incentives might include the following:

• Small additional services
• Discounts for early payments (balances paid before a certain date, or yearly invoice versus monthly)
• Greater flexibility (for instance, a down payment required to book a delivery date)

Some customers are just late payers and need to be nudged. The way that dunning is handled can, however, greatly affect the collection process. Timing and the quality of message content are the two main factors in the success or failure of these prods.  

How the business gets paid not only affects its profitability but also its cash flow. Today, paper checks remain the standard method of payment. However, paper checks are slow, highly susceptible to fraud and bear “hidden costs” such as additional work and back- office processing. They are also inadequate for recurring invoicing.

Something as simple as asking customers to switch to electronic funds transfer (EFT) or Automated Clearing House (ACH) payments, and providing incentives to switch, are among the steps that can ensure faster, more secure, more reliable and cheaper payments.

Improving cash flow

Profit doesn’t equate to cash flow because, as mentioned, cash flow and profit are not the same. There are many factors that make up cash flow, such as inventory, taxes, expenses, accounts payable and accounts receivable.

The proper management of cash outflows requires tracking and managing the operation’s liabilities. Managing cash outflows also means following one simple but basic rule: Pay the operation’s bills on time—but never before they are due.

Having a cash reserve can help any fabricating business survive the gaps in cash flow. Applying for a line of credit from the bank is one way to build that cash reserve. Once a business is qualified, lenders will grant a predetermined credit limit that can be withdrawn from when needed.

Yet another option might be frugality. Aim to keep the business lean by constantly evaluating it. Is the purchase of new equipment really necessary? Is hiring new employees really cost-effective? Weighing the pros and cons of all business needs and wants enables a business to retain cash flow and avoid unnecessary expenses.

Cash flow gaps

Remember, however, the cash flow gap in most fabrication businesses represents only an outflow of cash that might not be covered by a cash inflow for weeks, months or even years.  Any business, large or small, can experience a cash flow gap—it doesn’t necessarily mean the business is in financial trouble.

In fact, some cash flow gaps are created intentionally. That is, a fabricator will sometimes purposefully spend more cash to achieve some other financial results. The business might, for example, spend extra cash to purchase additional inventory to meet seasonal needs, to take advantage of a quantity or early payment discount, or to expand its business.  

Cash flow gaps are often filled by external financing sources: revolving lines of credit, bank loans and trade credit are just a few external financing options available to most businesses.

Cash flow loans

Cash flow-based loans rely on the value of the operation’s cash flow. If the operation has a strong cash flow stream, it can be used to get significant loan amounts even if there are few business assets. Although cash flow loans can be expensive, they play a key role in a business that is expanding.

An advantage of cash flow loans is the repayment period. These loans are usually designed according to the needs of the borrower, with repayment periods often between five and seven years. And, since cash flow loans are different from asset-based loans, rarely does collateral have to be put up.  

Flowing cash flows

Assessing the amounts, timing and uncertainty of cash flow is the most basic objective of cash flow management. Positive cash flow indicates the liquid assets of a business are increasing, enabling it to settle debts, reinvest in its business, return money to shareholders, pay expenses and provide a buffer against unanticipated financial challenges. The impact of a negative cash flow can be profound, with many businesses operating on margins so thin that frequent lost opportunities will put them on the path to closing their doors. 

Obviously, every business can improve its cash flow. Of course, for this to happen businesses need to adopt best practices in the way they invoice, follow up with customers and monitor outflow. With the help of a qualified professional, these cash flow best practices may be easier to achieve. 

Mark E. Battersby writes extensively on business, financial and tax-related topics.