Cash Flow Management

Best Practices for Small Business

Cash flow is the lifeblood of enterprise, and effective cash flow management is essential to the survival of businesses, big and small.  For small (and young) businesses, in particular,  the importance of cash flow is amplified by there finite resources and limited access to capital.  As such, small business founders are frequently forced to finance a venture themselves, which requires risking personal assets and reputation to obtain funds, stretching every dollar to the max, and constant tweaks to their business model as a result of knowledge gained.  Given this environment, financial oversight must be vigorously and constantly carried out to evaluate performance, identify potential pitfalls and present growth opportunities.

The following topics represent best practices that I use in managing my CPA practice and real estate investments, and they can help with managing your small business as well.

Utilizing basic accounting software

This may sound like a no-brainer for entrepreneurs of the 21st century, but I have worked with too many contractors and professionals that operate using a shoe box for a filing cabinet and a manual checkbook the size of an encyclopedia.  And while an old-fashioned, manual “system” can still get the job done, I strongly encourage self-employed individuals to utilize some type of basic accounting software (i.e., QuickBooks, Quicken, etc.) to aid in managing finances.  These applications make it easy to record transactions, print checks, preview reports, revisit historical information, and ultimately, they simplify the process for managing cash flow.

Posting transactions & monitoring activity regularly

Posting cash receipts and disbursements, customer invoices and vendor bills on a regular basis is crucial to maintaining accurate account balances in your accounting system.  The accuracy of your books is essential to effective cash flow management, as future cash flows are forecast (see Forecasting cash receipts & disbursements routinely, next) using book balances for cash, accounts receivable and accounts payable.

In addition to routinely recording transactions, you should monitor the following areas of your business regularly (at least weekly, if not daily):

  • Bank account(s) – I recommend daily review of cash transactions in-and-out of business bank accounts by way of online banking.  Several items to keep an eye out for include bank service charges, outstanding checks, recent deposits, and unauthorized disbursements.
  • Customer receivables – This topic represents the primary source of cash receipts for the majority of businesses, so it must be monitored closely.  At a minimum, accounts receivable should be monitored at the customer level and in the context of time outstanding (aging).  Identifying accounts creeping up on past-due status should be handled proactively, with communication initiated prior to becoming delinquent.  Working towards a mutually agreeable payment schedule is better than being left in the dark (from lack of communication) and assuming/hoping payment-in-full will be received.
  • Vendor payables – The goals with accounts payable are to minimize total expenditures and control the timing of cash outlays.  To accomplish these objectives, vendor bills must be entered into your accounting system timely and accurately so that payments can be issued as required by the terms of each agreement with vendors (and, thus, meeting due dates, avoiding penalties/late fees and applying discounts).

Forecasting cash receipts & disbursements routinely

Managing cash flow requires routine forecasting of receipts and disbursements to determine a cash surplus (deficit) in the immediate future.  I recommend preparing forecasts on a weekly or bi-weekly basis using information from your accounting system, as follows:

  • Cash-in-bank(s) at present,
  • Customer balances owed (i.e., Accounts Receivable),
  • Vendor bills owed (i.e., Accounts Payable), and
  • Payroll & related taxes from previous pay-period.

Based on the results of cash forecasts, I suggest creating a plan for investing funds arising from a cash surplus (see image below) or making arrangements to cover a cash deficit (see Establishing a source of working capital funds, next).

Establishing a source(s) of working capital

No matter how well you manage cash flow, your business will experience a “cash-crunch” at some point.  Not to be confused with cash deficit, the terms are defined below to highlight there differences.

Cash Deficit – in terms of cash forecasting, this is the excess of cash disbursements over cash receipts anticipated within the near term (i.e., 2-6 weeks).

Cash Crunch – refers to an unexpected cash shortage that threatens to significantly interrupt ordinary course of business

A cash shortage may arise from the loss of a major customer, an emergency repair requiring immediate payment, an economic downturn, etc.  Whatever the cause, there will come a time when your business requires an injection of capital, so protecting your business from significant damages caused by this inevitability is imperative.  Protecting your business from an inevitable cash-crunch can be accomplished by establishing access to funds in one or more of the following ways:

In closing, I contend that successful cash flow management requires detailed knowledge of your business’s finances, thoughtful/comprehensive planning, and the ability to adapt to unexpected changes in market conditions.  The best practices above are not meant to serve as an exhaustive list of the processes/procedures available for performing this management function.  Instead, they are guidelines that, collectively, represent a process for managing the flow of cash in and out of your business.  When implemented and carried out properly, these practices can expand your knowledge of the business, broaden the scope of your outlook when considering cash flows, and encourage you to spend some time thinking about your firm’s financial future.

Additional Resources:

Maintaining Health Cash Flow – How to Do It by Edward Wade

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