What does cash flow mean?
Whether you’re a small business or a large corporation, understanding and managing your cash flow is critical to the total financial health of the organization. Some analysts consider a good level of cash flow as a more reliable indicator of financial strength than earnings or dividends. This is due to earnings and dividends being susceptible to error or fraud in reporting. Comprehensive planning and radical reconsideration should be applied to existing cash flow systems in order to optimize the potential of stable cash flow systems to propel the profits of the company.
Cash flow strategies should respond to specify short-term and long-term financial goals. Short-term goals can be generating enough cash to meet basic day-to-day operating cash flow, monthly bills, rent, salary, savings, etc. Long-term goals are geared towards pension fund for employees, diversifying investments, expansion to new markets, pursuing new products, etc. A well-executed cash flow system can satisfy the wealth maximization goals of the company.
Components of Cash Flow
Some of the transactions that affect cash flow are fixed assets, accounts receivable, savings, profits, interest, and dividends, etc. These transactions are classified into operating, investing and financing activities.
Operating activities include net income, depreciation, changes in current assets and current liabilities other than cash and long-term debt.
Investing activities comprise investments and fixed assets.
Financing activities include cash from issuance of short-term debt, long-term debt or equity.
A simple cash flow statement reflects the firm’s ability to generate cash for future growth, repayment of debt or investment in new products. It also signals whether the company will issue more stocks or bonds. It’s amazing how cash flow tells a lot about the company that even the balance sheet and income statement cannot. Managers should realize the value of cash flow management as a tool for the enlargement of the business.
Here are some useful tips to keep in mind in planning cash flows:
Prepare a cash budget.
A well-conceived cash budget will make cash flow management easier. Managers should give thought to all financial aspects of the company and allocate cash to it based on experience or present calculations. In the ever increasing competitive environment, use of cash could easily go out of control. Having a cash budget encourages control and careful financial management.
Speed up collections.
Accounts receivable can be the boon or bane of the company. High sales are only as good as the prompt payment of receivables. Customers who owe you largely affect your cash flow system so it is very important to be on control of your accounts receivable. To make sure you are on top of your uncollected cash, orient you collection department on your latest collection policies. One way is to increase cash payment discounts to encourage prompt payment. Creating incentives for faster payments benefits both your customer and your cash flow.
Reexamine slow paying customers.
Be critical of who you do business with. At the onset of the transaction, take time to evaluate the customer’s capacity to pay. Do not deal with people with poor credit history. However, extend credit to financially robust customers. This is a simple strategy of picking the right apples from the tree. Many managers overlook the importance of keeping a reliable customer list.
Increase inventory turnover.
Avoid carrying inventory in storage for a long time. Keep the right timing of ordering and selling your inventory. Storage costs can reduce cash flow and obsolete items can make your liquidity suffer. Good supply management and inventory financing with Summit Financial Resources can boost your cash flow immediately by increasing inventory turnover and subsequently making cash promptly available for payment to suppliers.
Always claim discounts.
Pay your bills promptly to take advantage of the cash discounts. Do not let discounts go! Start ordering in bulk to claim larger discounts on your inventory. Also, improve your cash flow by cutting on your electric bills by conserving electricity and finding a strategic location with a competitive monthly rental.
Renegotiate contracts with suppliers.
Simply put, your payment period should match your collection period. If payment is due ahead of the collection period, the business could suffer a loss of cash for operations. Reach out to your suppliers and renegotiate the terms of your credit agreement to match your payment and collection. Most businesses have loans for equipment, business credit card, etc. Talk to your banker and consolidate your debt. You may consolidate your loans to enjoy lower interest and improve your cash flow. Increasing the repayment period will also improve cash flow due to smaller monthly payments.
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