The Importance of Business Cash Flow Management

Coins with a line chart and bar chart – meant to indicate the uncertainty in business cash flow management

No matter how much profit a business generates, poor cash flow management can lead to disaster. In fact, a recent study found that 82% of small business failures can be attributed to poor cash flow management – a factor more impactful than too little starting capital or even lack of a well-developed business plan.

An effective cash flow management plan can do more than help businesses avoid bankruptcy. It can ensure that bills are paid, promote positive relationships with vendors, and even help companies take advantage of expansion opportunities. With so much to be gained, it is vital that businesses work hard to hone their cash flow management practices.

Poor Cash Flow Management Plagues Businesses – Large and Small

Cash flow management is not so much about revenue and expenses as it is about the movement of cash throughout a business. There are many ways that cash management can go wrong, and even the largest organizations are not immune.

As an example, Greece ran into serious trouble when it didn’t have enough cash flow to cover its outstanding loan obligations. Greece’s debt-to-GDP ratio was not unlike many other developed nations, but when cash flows dwindled during the financial crisis, it needed external help to save itself.

While not a typical business, Greece is just one example of how even the largest of organizations are susceptible to cash management issues during an economic downturn. For smaller organizations, this risk is often much greater.

Small business cash management can be challenging.

A strict focus on profits can sometimes take away from the importance of being cash flow positive, especially for small or growing businesses. In many cases, small businesses do not fail because they stop making profits, they fail because they run out of cash.

It is important to analyze cash flow regularly to stay on top of changing cash trends, but that is just the tip of the iceberg. Effective cash flow management also means an organization must determine the optimal level of cash reserves to keep on-hand to meet their obligations. For smaller organizations, the challenge of maintaining enough cash to operate effectively can be even greater – mainly because smaller revenue streams leave less room for error.

Tips for Effective Cash Management

There are a few things that business managers can do to improve their cash flow management process. Some of these tasks are simple while others require some planning, so it’s critical to get started immediately.

Create Forecasts that Account for Unexpected Situations

To be effective at managing cash, businesses must create forecasts with a series of “what-ifs” – such as a large client moving elsewhere or an unexpected expense. For companies with a shorter client list, this type of planning is even more critical to long-term sustainability.

By analyzing as many potential scenarios as possible, businesses can identify and spotlight the areas of highest risk to operations. Then, managers have the information they need to plan accordingly. After all, planning and awareness are what cash flow management is all about.

Keep Sufficient Cash on Hand for Emergency Response

Along with identifying risks, businesses should prepare their response to those situations. Often, this involves keeping sufficient cash on hand to react quickly when machinery breaks, buildings need maintenance, or inventory is damaged. Businesses that maintain adequate cash reserves are also equipped for unforeseen market conditions – like downturns in demand, shortages in supply, and logistical delays.

The amount of cash reserves required for a business differs by industry and organizational structure. In general, a business should have sufficient emergency cash to cover operating expenses for several months in the event of a revenue disruption.

Plan for Capital Expenditures

An effective cash flow management plan can also help businesses prepare for future expansion. Putting money aside during good times can help to ensure that a business is prepared for growth activities like purchasing a subsidiary, buying a new building, or investing in a piece of equipment. A business that plans for capital expenditures ahead of time ensures that they have sufficient cash to make the purchase or to acquire preferrable financing.

Consider Liquidity

To react swiftly to emergencies or expansion opportunities, a business must ensure that their cash reserves are accessible when they need them. That is why liquidity management – the act of balancing accessibility with returns – is essential to an effective cash flow management strategy.

Liquidity management allows a business to invest immediately if an opportunity for increasing market share or delivering more value to customers arises. Whether the opportunity is new technology, new talent, or a new idea, a business with appropriate liquidity can capitalize without the delay of selling off assets.

Delay Cash Outflows When Possible

There are two major aspects to cash flow management: inflows and outflows. When managing outflows, it is important to cut expenses when possible and put off spending money for as long as is feasible while still avoiding penalties. At the same time, make sure to have a positive working relationship with vendors and maintain a good credit rating to allow for negotiating the best payment terms.

Another large source of outflows is capital expenditures. Cutting those costs can have a major impact on cash flow. For example, repairing equipment or buying less expensive used equipment can ease outflow pressure. Further, delaying upgrades or replacements until they are necessary keeps cash in hand longer and stretches cash further.

When purchases are unavoidable, financing large orders can stretch cash flow. In addition, smart businesses will slim down inventories as much as possible without interfering with business needs.

Keep Inflows Timely and Predictable

For optimal cash management, inflows should be collected as soon as possible. Offering discounts to customers for paying faster, even as little as 2%, can provide just enough of an incentive for clients to pay their bills sooner. Business managers should also follow up quickly on late payments and reassess business deals that aren’t performing.

For additional cash flow security, many organizations are leveraging escrow services. By utilizing business escrow, firms can ensure payments aren’t delayed, especially with costly or time-consuming projects.

Plan for Seasonal Demand

Businesses that are highly seasonal can experience considerable fluctuations in their cash flow throughout the year. This may leave them flush with cash during the “on-season” and struggling to meet obligations during the “off-season.” Tackling these issues requires accurate forecasting and budgeting, but these companies may also benefit from diversification.

Diversifying a business so that it can generate sales year-round can help to smooth seasonal cash flow. This could mean expanding into a different market where the peak season is at a different time of year or creating an online store to find customers in new geographic areas.

Ensure Cash Reserves Earn a Competitive Return

Whether funds are earmarked for expansionary projects or are set aside for an emergency, cash reserves are intended to bring value to the company at a future date. However, when there are funds not being used for immediate profit, there is opportunity risk – meaning that cash could create additional value if put to work. This risk can be mitigated by ensuring that cash reserves are earning a competitive rate of return.

As reserves grow, it becomes more important to ensure that they are earning a return. Because of inflation, cash that isn’t working loses value, and that can reduce the effectiveness of a cash management program. If reserves are earmarked for a long-term purchase, the effects of inflation can be even more severe without proper planning.

Keep Business Cash Safe and Working

Proper investment of short-term cash provides extra income without sacrificing safety or liquidity. That’s what led our company, the American Deposit Management Co. [ADM], to develop the concept we call Marketplace Banking™ as an enhancement to your current banking relationships.

Marketplace Banking™ means businesses can receive ‘twice a week’ liquidity and access to full FDIC / NCUA coverage – enhanced by nationally competitive returns. Further, when expenses are predictable and regularly scheduled, the ADM team can develop a CD ladder designed to optimize returns while maintaining your liquidity schedule.

In addition to the protection and return provided by Marketplace Banking™, ADM provides a full suite of cash management solutions that helps businesses reduce the risk and workload required to manage of their cash flow.

Earn More, Risk Less® with a Full Suite of Cash Management Services by ADM

At ADM, our goal is to provide organizations with access to unparalleled safety and nationally competitive returns. When businesses work with our team of deposit consultants, we will work to understand their needs and develop a strategy to optimize their cash management plan. Our team is our secret sauce, and you will understand that once you give us a call.

For even more valuable insights on banking, interest rates, and effectively managing business cash, be sure to check out our Insights page and follow us on LinkedInTwitter and Facebook.


*American Deposit Management Co. is not an FDIC/NCUA-insured institution. FDIC/NCUA deposit coverage only protects against the failure of an FDIC/NCUA-insured depository institution.

Tags: , , ,