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The Basics of Cash Flow Management

cash flow risk management

For business owners, understanding the basics of cash flow management is paramount to gaining control over business finances. Many business owners have difficulty determining where all their revenue goes. Thus, some weeks are good, and others are bad. Yet, comprehending the inflows and outflows of cash is crucial to cash flow risk management. For small and mid-sized businesses, cash flow management is an essential component of success. Below, we explore the basics of cash flow management to best prepare for daily challenges of running a business.

Cash Flow: An Introduction

Cash flow can be defined as the total sum of money transferred into and out from a business. When calculated, the net sum reveals either a positive or negative amount. Of course, positive cash flows are critical to keeping a company going, growing, and demonstrating value to investors. Extended periods of negative net cash flow should cause concern.

Like other financial reporting methods, cash flow is tracked over a predetermined period.

Cash Inflows

Cash inflows are incoming sources of money, which include:

  • Operating activities – cash received from the sale of a good or service.
  • Investment activities – cash received from return on investment funds.
  • Financing activities – cash received from incurred debt.

Cash Outflows

Cash outflows are outgoing sources of money, which include:

  • Operating activities – cash paid for operating costs, such as utilities, cost of goods, and payroll.
  • Investment activities – cash paid into investments, such as vehicles or fixed assets.
  • Financing activities – cash payments towards interest, principal, etc.

Cash Flow Management

Cash flow management is the act of tracking and analyzing theinflows and outflows of cash. Proper management allows business owners to evaluate positive or negative net cash flow trends and predict how much money may be available in the future.

Does your business have enough money to keep running? What changes should you make to ensure future profitability? These are the questions proper cash flow management should answer.

Cash Flow Risk Management

Proper cash flow management is risk management. Cash flow at risk (CFaR) is the determined extent to which your future cash flow may be inadequate. The Association for Financial Professionals defines the concept of CFaR in detail:

CFaR is an excellent corporate risk measure because it will improve the understanding of the risk dynamics of a business and how that risk profile can change due to price changes, entry of new products or geographies, acquisitions, or new projects coming into production. It generally focuses on the market risk that impacts the corporate’s cash flows, ignoring things such as political, operational, environmental, and legal risk.

The Association provides a helpful example of calculating CFaR. If your business’ forecasted cash flow for the next year is $15 million, but the forecasted cash flow at the 95th percentile is $10 million, your cash flow at risk is $5 million. Therefore, over a 12-month period, there is a 95% chance that cash flow will drop by ~ $5 million and a 5% chance it will drop by more.

Proper cash flow risk management begins with evaluating cash inflows, outflows, and net profit to properly forecast and strategize for future financial challenges.

Cash Flow Statements vs. Income Statements

Before addressing strategies to solve common cash flow management issues, it is critical to differential between cash flow statements and income statements. While both statements make up a corporate balance sheet, they differ in one significant way.

Cash flow statements – divided into operating, investing, and financing activities – measure the exact sum of cash inflows and outflows during a set period, usually a month.

Income statements measure a company’s total revenue and expenses including noncash accounting, over a set period. Depreciation is an example of noncash accounting.

However, both statements are linked to each other. Net profit (from the income statement) is utilized to calculate operating activity cash flow (on the cash flow statement).

Why is Cash Flow Management Important?

In any area of financial management, even personal budgeting, consistently spending more than you earn will result in a cash flow problem. For some businesses, serious cash flow problems occur due to a simple lack of comprehending inflows and outflows. Nearly 82% of businesses fail due to a lack of cash flow management.

Cash flow management is vital as it prevents extended cash flow shortages, resulting in the inability to pay bills and business expenses – ultimately causing business failure.

How Can a Business Owner Solve Cash Flow Management Problems?

  • Businesses owners should regularly perform a cash flow analysis.

A cash flow analysis is the study of your business’ inflow and outflow patterns. An analysis provides the basis of proper cash flow management. To perform a simple cash flow analysis:

  1. Examine all business components that affect cash flow, including inventory, credit terms, and accounts receivable.
  2. At the end of every month, measure your total unpaid purchases against total sales. Of course, if you find that you spent more cash than you received (outflows outweighed inflows), you may be facing a cash-flow problem.
  • Develop effective cash flow strategies to maintain proper business cash flow.

One simple strategy involves shortening cash flow conversion periods to allow for quicker inflows.

If you feel overwhelmed or confused by the components of proper cash flow management, it may be time to seek the assistance of professional consultants. Cash flow issues cannot be ignored. Reach out for help if needed!

Cash Flow Management with Ionji Consulting

At Ionji Consulting, our team of financial experts mentors business leaders, helping improve and optimize systems and procedures for maximum revenue, including helping you analyze and forecast your cash flow.

Our team utilizes a proprietary program that produces a cash flow forecast. We input all crucial information (accounts payable, accounts receivable, recurring expenses, payroll, etc.), and the program provides insight into negative or positive cash flow balances on a forward-facing basis.

Let us demonstrate how we can rejuvenate your business with a free, confidential business consultation with absolutely no obligation to purchase services.

To get in touch and schedule a consultation, please do not hesitate to reach out at 800.714.3428 or via our online contact form!

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