Financial Literacy: Entrepreneurs must manage Cash Flow to Survive

Nov 05, 2017 News

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Dr. Terence Smith, Deputy Governor, Bank of Guyana

Why is cash flow and cash flow management so important?
The focus of this article is on cash and cash flow (liquidity) management. Cash flow is generally

acknowledged as the single most pressing concern of the SME (small and medium sized enterprise). The research literature has shown that cash flow challenges are a common concern among entrepreneurs around the world.
In fact, small businesspersons cannot survive if they cannot manage their company’s cash flow. If cash flow is not maintained, it can easily put a strain on the business and in extreme cases, cause it to shut down.
A U.S. Bank study found that 82 percent of small businesses fail due to poor cash flow management skills. So let us discuss what is cash flow and cash flow management.
According to Investopedia.com, cash flow is the movement of cash into or out of an account, a business, or an investment over a given period. The cycle of cash inflows and outflows plays a crucial role in a business’s financial health. A business is in good financial health when cash inflows exceed outflows.
Along the same line, cash flow management describes the process of anticipating and planning for cash receipts and disbursements. Specifically, cash flow management is the process of managing the short-term liquid resources of the business to optimize its results. Poor cash flow management is one of the leading causes of business failures.
The literature indicates that many businesses fail not because they are not profitable, but because they run out of cash. Thus, the statement of The Business Development Bank of Canada (BDC): “Businesses can run for an extended period of time without being profitable but fail the day their cash reserves dry up.”

The challenges of cash flow management
Understanding your business’ cash situation is crucial to making sound business decisions. SME owners must strive to understand and “always be in-touch with the cash aspects of their enterprise, regardless of the profits reported.”
Cash flow management research performed by BDC has shown that approximately 70 percent of business owners know their exact cash positions or balance, while another 28 percent have an approximate understanding of it. Nevertheless, the research identified several issues relating to the cash flow of business owners as respondents to the survey:
· Being passive about collecting receivables (late or irregular payments)
· Not keeping a cushion of cash on hand or having enough cash to cover expenses
· Paying suppliers before receiving payments from clients (timing between accounts payable and accounts receivable)
· Preparing cash flow projections and not using a cash flow budget
· Dealing with fluctuating demand and sales; overestimating future sales volume, and
· Accessing additional credit or financing.

Some ideas on managing cash flow correctly
An effective cash flow management strategy can streamline SMEs’ daily operations and transform revenue into profits. There are several factors to consider with cash flow, but the key is “If your expenses exceed you cash, then you have a cash flow problem.”
Cash flow is the lifeblood of a business and critical in its growth. According to Caron Beesley, contributor to the U.S. Small Business Administration, “small businesses are hugely dependent on their cash flow, and must either cut costs or scramble to find alternative funding when they are not being paid on time.
With money tight and bank loans hard to get, a cash strapped company can easily be pushed to the brink.”

The following are the basics of good cash flow management:
1. Do not be passive about past-due receivables – Jared Hecht one of the contributors at Entrepreneur.com indicates that one of the fastest cash flow killers for small businesses results from unpaid invoices from clients. “If you are not being proactive about collecting payments from your clients, you could be on your way to a dangerous cash flow situation.” Good accounting practices suggest that keeping an organized ledger is necessary for cash flow. This will also help to speed up debt collection.
2. Use a cash flow budget – A budget helps you to set realistic expectations for future sales. Use budgeting software to create a detailed forecast and use that information to drive your business is one of the most impactful steps you can take to manage cash flow effectively.
3. Keep a cushion of cash on hand – If your business has a zero account balance, one month of slow sales could mean instant disaster. So plan ahead and know where your cash is tied up. Set money aside to safeguard your business from cash flow issues; maintain an account balance equivalent to at least two months of operating expenses.
4. Secure credit before you actually need it – Access to credit can make or break your business. The Red Door Capital Group suggests that, “the sooner you prepare your funding options, the less scrambling you will have to do later when cash flow becomes a problem.”
5. Do not overestimate future sales – Use a basic spreadsheet as your tool for cash flow projections. By applying quantitative forecasting methods, you can use actual past revenue data from your own business or other businesses in your industry as a basis for tracking trends and predicting future sales.
6. Do not spend recklessly – There are practical steps you can take to minimize your overhead costs. In the start-up phase, “keep your eye on the bottom line, considering the cost-benefit of every single expense.” Most new enterprises do not need massive office space or a large warehouse for inventory. Budget planning is essential. Make sure to spend your resources on expenses that will benefit the enterprise.

Concluding remarks
Good cash management activities include maintaining sufficient reserves, minimizing idle resources, investing for future expansion and reducing borrowing and processing costs. In effect, cash flow management is vital to the health of your business and its long-term viability.

Next week we will examine some more aspects of financial education for entrepreneurs. Please send your comments or questions to [email protected]

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