Every year, lots of businesses face significant issues related to insufficient cash flow. Late payments are often considered a key factor behind this poor flow of income. When income arrives later than expenses are due, it throws off the balance between payables and receivables, creating a financial crunch. To avoid this, it's essential to maintain a healthy balance, ideally resulting in a net positive cash flow.
Cash flow problems can trigger severe consequences including operational disruptions, a damaged business credit score, stagnant growth, loss of investor confidence, debt accumulation, and in extreme cases, bankruptcy. It’s not just small businesses either, growing and profitable companies can encounter these challenges too. Inventory overstocking, insufficient cash reserves, overambitious business expansions, and poor financial management are among some of the other contributors to cash shortages.
So, how do you sustain a healthy cash flow? Here are some tips and strategies businesses might turn to depending on their circumstances:
1. Lease over buying
While the prospect of buying equipment and real estate appears promising in the long run, businesses struggling to maintain a steady cash flow may find leasing to be a more beneficial choice. Leasing eliminates the strain of upfront costs, safeguarding cash reserves. Instead, it allows the company to use the leased items by paying manageable monthly instalments that won't disrupt their cash flow. Additionally, these instalments are considered expenses and can be written off for tax purposes. Moreover, lease agreements often include service and maintenance, eliminating further expenses.
2. Cut back on unnecessary spend
When aiming to conserve cash, it is crucial to manage capital carefully. Businesses should review their expenses and take spend management seriously. During this review, some expenses may be identified as unnecessary, such as unused machinery, excessive office space, or subscriptions that can be discontinued. Though each saving might seem insignificant individually, together they can create a substantial saving.
Efficient expense management allows you to redirect saved cash towards activities that generate revenue, like investing or moving this money into a high-interest savings account.
3. Improve inventory management
Excess inventory, especially slow-moving or low-demand goods, can become dead stock, hindering cash flow by tying up valuable resources, occupying storage space, incurring fees, and representing idle capital that could be used for revenue-generating activities. Regularly monitoring inventory can help identify such items, allowing businesses to make informed decisions to reduce production and offload unused stock at discounted prices.
Proper inventory management can help optimise stock levels and cash flow. For instance, using forecasting processes, businesses can accurately predict customer demand. This helps with ordering the right amount of inventory and significantly reduces overstocking. Similarly, by adopting the Just-in-Time (JIT) strategy, storage expenses and tied-up capital can be reduced. Additionally, the ABC analysis method helps prioritise managing high-value, slow-moving items to ensure efficient cash flow.
4. Levy incentives and penalties
For a steady cash flow, receiving payments on time is crucial. Implementing incentives and penalties can be a great strategy to achieve it. Offering rewards like discounts for early settlements can motivate customers to pay promptly. Moreover, implementing reward schemes and referral programs can stimulate punctual payments and drive sales, ultimately boosting revenue. These incentives could include discounts on future orders or gift certificates, providing additional value to customers who pay on time.
Similarly, imposing additional fees for overdue payments can motivate customers to adhere to payment deadlines. It's crucial to clearly outline such late payment fees in the contractual agreement between parties. Ensure that invoices are transparent, featuring easily understandable terms, due dates, and late fee information. By including details about incentives and penalties in the invoice, clients are immediately prompted to act.
Sending payment reminders can also serve as helpful nudges to prompt customers to settle their accounts. Furthermore, automating accounts payable and receivable functions can streamline these processes, making them more manageable.
5. Prompt invoicing
To make payments on time, customers should first receive invoices promptly. Businesses should not delay sending invoices, they should be issued as soon as the goods or services are delivered. This practice can expedite the payment process, minimising late payments. Prompt invoicing also reduces the likelihood of invoices being overlooked or forgotten, further ensuring timely payments. Overall, it can improve Days Sales Outstanding and help maintain a steady cash flow.
6. Adopt electronic payments
Businesses should offer a variety of payment options to reduce roadblocks and provide convenience for customers. Adopting electronic payment methods can accelerate payment processing and improve cash flow efficiency. With electronic payments, a payment link can be attached to the invoice, enabling customers to pay immediately with just a click.
An invoice management and accounting software integrated with electronic payments can further streamline the process and free up valuable time and resources.
7. Negotiate better payment terms
Don't hesitate to negotiate favourable payment terms with both receivable and payable parties to optimise cash flow timing. Keeping a good and friendly relationship with your suppliers can help you secure these deals like longer payment durations and lower interest rates. By extending payment terms, you gain additional time to make sales before your vendor payments are due, helping prevent shortages.
Maintaining a transparent, respectful business approach, regular communication and having a history of timely payments can foster strong relationships. Taking advantage of early payment discounts if offered can give your profit margins a nice boost when cash is flowing well, while also giving you some breathing room during slower times. Ultimately, mastering the art of negotiation can lead to better deals all around.
8. Conduct thorough customer credit checks
In B2B trade, extending credit terms to customers is common. However, it's crucial to thoroughly assess their creditworthiness before doing so. A credit check provides valuable insight into their credit score and past financial performance, helping you gauge the risk of late payments. A poor credit score suggests a history of delayed payments, increasing the likelihood of similar behaviour with your business. Transactions with such customers can strain your cash flow more than they benefit your revenue.
If you choose to extend credit despite some credit risk, consider strategies like requiring a larger down payment, shortening the payment terms, or implementing stricter late fee policies. Clearly outline these terms and potential consequences of default (such as collections efforts or legal action) in your agreement with the customer.
9. Cash flow forecasting
Improved cash flow is one of the key reasons a business should implement forecasting. By analysing past financial performance, companies can project this forward to estimate future revenue/outgoings. This analysis reveals cash flow fluctuations and trends, helping to identify potential durations of cash surpluses or shortages. And this information aids in preparing accurate budget forecasts and future planning.
Cash flow forecasting provides insights that enable better cash flow management. Having this data, organisations can prepare contingency plans and strategically allocate resources. This ensures sufficient funds cover expenses during lean periods and allows for investment in growth opportunities during periods of prosperity.
10. Consider price adjustment
While price increases can be challenging, they might be necessary to sustain your business's financial health and stability. Increasing prices becomes necessary when the costs of raw materials, labour, and other operational expenses rise, impacting cash flow. Adjusting prices in such situations is essential to offset increased production costs.
Raising the price of your products and services can be a sensitive issue. It requires a strategic approach and careful consideration of market and customer reactions. Effective implementation of price increases often involves making marginal adjustments and keeping prices competitive. Avoid raising them too much compared to your competitors. This can help maintain your market position and customer base while addressing the need to cover higher costs.
11. Join a buying cooperative
Suppliers often provide discounts for bulk orders, with larger orders yielding better deals. This may not be feasible for small businesses due to limited storage space or lack of capital. Nonetheless, they can still reap the benefits by participating in a buying cooperative. This arrangement involves multiple businesses consolidating their purchasing needs into a single contract to increase their purchasing power. By pooling demand, participants can negotiate lower prices from selected suppliers and enjoy more favourable terms and conditions.
12. Invoice factoring
In invoice factoring, the company sells its outstanding invoices to a third party, typically receiving immediate cash amounting to 70-90% of the invoice value. The factor then assumes responsibility for credit control and collection from clients, deducting a service fee before remitting the remaining balance to the company. This method offers a low-risk approach for recovering high-value unpaid invoices, providing an alternative to waiting for customer payments and facilitating immediate access to cash. However, it's crucial to acknowledge the possibility of customer default. In such instances, the factor may necessitate the business to repurchase the invoice or cover the outstanding amount.
13. Leverage technology to improve your cash flow
With technology rapidly accelerating, accuracy and efficiency are improving across all functions of a business’s finance department, including cash flow management. Using financial management software, such as Financials, you can maximise your efforts to improve cash flow.
This innovative system supports in-depth financial analysis, helping you to review spend and identify cost saving areas. It helps with forecast and preparing accurate budgets, while facilitating prompt invoicing too via automation.
Financials enables finance teams to seamlessly integrate all elements of the accounting process, including general ledger, accounts payable, credit management, and bank reconciliation, as well as modules for inventory management and fixed asset management.
From simplifying accounting to generating accurate forecasts, Financials equips you with the insights needed to optimise your cash flow.