Guide to Cash Flow Management: Steps, Examples & Importance

Introduction

The most critical part for any business is to maintain stable cash flows, while fulfilling their financial obligations. However as businesses scale, there are ever-increasing amounts of payments due from customers, expenditures on expansion plans, debts, unsold inventory on the floor, taxes and interest in the books. With high transaction volumes, businesses often lose track of their reserves, which end up affecting their liquidity, financial position, and returns. This is where robust cash flow management comes into play.

Cash flow management helps businesses ensure a steady flow of funds so they can meet day-to-day expenses, settle financial obligations, and capitalize on expansion and growth while navigating unexpected events or contingencies. An efficient cash flow management system is the key to establishing a financially stable business and keeping operations up and running. 

This blog discusses cash flow management in great detail. It will cover the meaning of cash flow management, goals, examples, issues, and how leveraging automation and cash management solutions can help businesses navigate those challenges seamlessly.

What is Cash Flow Management?

Cash flow management involves evaluating, tracking, and optimizing a business’s cash flows while gaining insights into these financial movements . With cash flow management, companies can unlock accurate cash forecasting and ensure timely payments and reserves to meet unexpected financial needs.

Cash inflows include sources like proceeds from sales, payments from customers, short-term investments, marketable securities, interest on savings, etc. While, cash outflows usually involve payments such as accounts payable, short-term loans, payroll, taxes, administrative expenses, etc.

Effective cash flow management helps businesses ensure that their cash inflows exceed their outflows, ensuring that they have sufficient working capital to meet their operating expenses. It also helps them leverage reinvestment opportunities for better growth, paving the way for higher returns. 

What Is The Main Aim Of Cash Flow Management? 

As the saying goes, “Revenue is vanity, profit is sanity, but cash is the king.” This adage holds true for businesses of all sizes today. Did you know that a staggering 82% of businesses that failed cited cash flow issues as the primary reason according to a US Bank study? To prevent such outcomes, businesses need robust strategies to track, analyze, and optimize all cash movements. 

Effective cash flow management helps businesses strike a balance, ensuring enhanced long-term productivity while maintaining short-term cash flows. It sustains required liquidity at lower costs, improves operational performance metrics and provides higher outcomes and returns. Here are some of the primary objectives of cash flow management:

• Effective cash flow control 

  Cash flow management helps businesses curb cash outflows while accelerating cash inflows. It helps businesses retain sufficient liquidity to meet contingencies, ensure shorter cash cycles, reduce operational and tax expenses and maintain solvency levels. 

• Leverage growth opportunities 

  When done right, cash flow management helps businesses leverage growth and expansion opportunities by planning asset purchases, forecasting capital expenditures, and efficiently tracking additional funding requirements. 

• Ensure regulatory compliance

  An effective cash flow management system helps businesses maintain accounts, create cash budgets and undertake cash flow planning. This prevents critical errors, accurately records all cash receipts, and ensures accurate financial accounts.

• Ensure clear communication

  Business operations rely on external and internal communications with stakeholders. Cash budgets and cash flow statements prepared during the cash flow management process provide transparency helps frame detailed forecasting assumptions and build trust, ensuring clear financial communication.

Calculations In Cash Flow Management 

Effective cash flow management involves various methods of cash flow management. However, finance teams prefer using free cash flow, operational cash flow, and cash flow prediction formulas to guide cash flow management strategies.. 

Free cash flow refers to a business’s surplus cash that could be distributed among stakeholders or reinvested in business for purchasing new machinery, launching new products or expanding in new locations. 

Operational cash flow helps businesses determine how much cash is required to meet core operating expenses. It includes cash received from customers less the amount spent on daily operational needs like salaries, rent, raw materials, etc. Note that cash flow from investing and financing activities are not included here.

A cash flow projection gives businesses a holistic view of future cash inflows and outflows over a given period. It is a critical tool to identify potential cash shortfalls or surpluses, optimize cash flow management, address short-term liquidity concerns, and streamline financial planning. 

Cash Flow Management Examples 

Let’s take two examples: one with a cash shortfall and the other with excess cash. 

Example 1: Shortfall of cash 

Suppose a small retail business faces a seasonal downturn in sales during the summer months. Despite prior forecasts, the businesses underestimated the extent of revenue decline and overestimated their ability to cover expenses. As a result, they find themselves with inadequate cash flows to meet financial obligations like payrolls and suppliers’ credit.

To manage the shortfall, the business will now implement a cash flow management system and implement strategies like negotiating payment terms with suppliers, reducing discretionary spending, and securing short-term debts to fund operations until there is adequate revenue from sales. 

Example 2: Excess cash 

 A mid-sized tech firm witnesses a sudden surge in revenue after launching a new product. The company now has excess cash flow beyond its immediate operational needs. To maximize the value of surplus cash, the company decided to implement a cash flow management strategy. This entails the company identifying opportunities to invest the excess funds towards business expansion and marketing campaigns to fuel growth, acquiring new talent, or building reserves for future investments, ensuring long-term financial stability and flexibility. 

Common Cash Flow Management Issues

Businesses often face numerous cash flow management issues such as lack of cash reserves, absence of automation, error-prone manual processes and seasonal business nature., Let us understand these challenges in detail:

• Lack of cash reserves

  Insufficient cash reserves lead to difficulties in meeting both regular and unplanned needs, leading to insolvency and the inability to cope with downturns or other disruptions. The only solution for businesses is to rely on sales and timely payments, which in turn leads to weaker cash flow health.

  

• Lack of automation, centralization and standardization

  Many businesses still rely on conventional methods of conducting cash flow management using spreadsheets, rather than centralizing the data for forecasting. While this might seem like an effective cost-saving method, businesses end up dealing with a lack of standardization and poor decision-making.

• Manual and error-prone processes

  Relying on spreadsheets is not only a tedious, manual process but also leads to errors in integrating, entering, and confirming huge volumes of data. Manual feeding of cash flow data not only results in inaccuracy but also requires substantial time and efforts from the teams that could have been used for a more productive purpose.

• Cash flow struggles 

  Businesses often have a hard time tracking their cash flows due to a lack of standardized processes to calculate cash inflows and outflows. Also, factors like difficulty in payment collection and excess inventory investments lead to cash flow struggles, resulting in higher withdrawals and borrowings, panic purchases and ineffective risk controls.

• Delayed payments 

  This mostly happens when businesses lack an efficient accounts receivable system in place. Incomplete payments from customers can block the expected cash flow balance, creating hurdles when paying taxes and interests.. 

  

• Seasonal business fluctuations

  Businesses with a seasonal or highly cyclical nature often face cash flow problems due to varying revenue streams throughout the year, which declines during the off-season. One solution is to conduct a spend analysis and project fixed expenses to ensure consistent cash flow. However, this would be a tedious, repetitive process as businesses would have to manually gather procurement data and identify purchase by cost opportunities.

• Rapid but unplanned expansion 

  Fast growth is usually a good sign for businesses, but it often tends to disrupt business cash flow. Businesses need to allocate reserves to stock up and hire more labor to meet the rising demand. This often exhausts all funds, at least until better returns are realized.

How To Manage Cash Flow In Business: Process

The cash management process includes cash flow analysis, cash flow forecasting and cash flow optimization. The easiest way is to create a cash flow statement, identifying the risks of declining reserves. Here’s how to manage cash flow: 

• Create cash projections
• Prepare cash flow statements
• Track cash flows
• Implement strategies 

• Create cash projections

  The cash flow management process starts with estimating revenues and expenses. Businesses can use historical data, sales projections and income statements to create cash flow projections. It is recommended to make cash projections for shorter durations, like four to six weeks. The longer the duration of projections, the more misses there are in the forecasts. 

  Additionally, solutions like AR-AP forecasting can also help businesses boost the accuracy and efficiency of cash projections. They can forecast payments from customers and anticipated cash outflow to suppliers in the near term by leveraging custom-built AI models for AR and AP forecasting. Also, auto-ML powered category forecasts can help analyze historical transaction data to create cash forecasts and select the best fit model category and time frame for relevant and accurate projection results. 

  

• Prepare cash flow statements 

  The next step is to plug the cash flow projections into cash flow statements. Businesses can categorize cash flows based on operating, investing, and financing activities to get a holistic view of their cash position. This will help track working capital requirements and bridge the gap between inventory, receivables and payables. 

• Track cash flow regularly 

  Businesses must regularly monitor, update, and compare projected cash flows with actual numbers. If cash flow statements have any shortfalls, businesses must analyze and identify the underlying reasons behind variances using variance analysis and possible mitigation measures. It could also include changes to assumptions drawn during the projection and know the actuals vs forecast for better planning.

• Implement corrective measures 

  Businesses must optimize their financial position by implementing corrective measures to streamline cash flow issues. This can include steps like accelerating cash collection, reducing discretionary spending, negotiating favorable payment terms and identifying reinvesting opportunities. 

  Some other tips 

  • Improve inventory management

    Adequate but balanced inventory is a critical component of effective cash flow management. Businesses must digitize their inventory management to streamline operations, reduce stock waste, and replenish inventory on time. Numerous inventory management solutions are available that help businesses track inventory-related costs and manage excess inventory that blocks working capital. 

  • Manage accounts payable

    If a business has an inadequate cash reserve to settle account payables like payroll or vendor payments, it would either need to borrow external funds or issue shares or bonds to cushion operations. To ensure sound cash management, businesses must implement an efficient accounts payable forecasting system and find out how much money they need to allocate to ensure timely payments. 

  • Automate bank reconciliation

    One of the major reasons for inaccuracies in cash flow management is the errors and omissions that occur during processing bank statements and positioning cash manually. Automated bank reconciliations, supported by algorithms and auto-cash transactions, help businesses track bank connectivity, balance and reconciliation status at the account level and identify outstanding transactions to handle exceptions, thereby streamlining cash flows. 

How HighRadius Can Help Businesses Boost Cash Flow Management

The key to building a robust and effective cash flow management is to automate the process. HighRadius’ treasury and risk suite brings state-of-the-art cash management and cash forecasting solutions that not only help automate the error-prone manual process but also ensure dynamic projections and help update changes in cash flow in real time. 

• The cash management solution comes with features like automated bank reconciliation, daily cash visibility, and cash positioning to analyze cash using dynamic dashboards and evaluate global cash position across regions, accounts, companies, etc. 
• The cash forecasting solution, on the other hand, offers a plethora of tools like historical forecasting and auto ML forecasting features to help businesses implement forecasting models that best-fit cash projection needs
• Businesses can also use features for variance analysis to understand the reasons behind changes in cash flows. They can also conduct what-if scenarios using scenario builders to identify the financial position in the near term and build reserves to meet contingencies. 

The result? Businesses can reduce idle cash by 50%, while increasing cash management and cash forecasting productivity by a whopping 70%.

FAQs

1) What is the relationship between AP and cash flow management?

Accounts payable (AP) directly impacts and is a crucial element in determining cash flows. It refers to the money a business owes to vendors. Effective cash flow management helps businesses strike a balance between timely payments and delaying transactions for healthy cash reserves. 

2) What is the importance of cash flow management?

Cash flow issues can turn into a major setback if businesses don’t have a documented strategy to manage cash flows. Effective cash flow management will help businesses streamline these cash flow strategies, prioritize a healthy financial reserve, and maximize cash flows to meet uncertain events. 

3) How to manage cash flow in a small business?

One of the key elements to improving cash flow is to constantly monitor it. Here are five ways to improve cash flow in small business: 

• Streamlining payments 
• Reducing discretionary spending
• Building funding sources 
• Redefining business strategies 
• Effective cash flow management 

4) Why are cash flow statements useful for managing money?

Cash flow statements are useful for managing money because they give businesses a holistic view of their cash flows. It helps businesses: 

• Get a clear understanding of payments 
• Maintain optimum cash reserves
• Focus on generating cash 
• Build robust cash forecasting and analyze changes in cash flows