What is cash flow management and why is it important?

By Indeed Editorial Team

Published 27 June 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Businesses require access to cash to operate successfully. Cash flow management is essential to the financial reporting and planning of a business. It ensures the balance between money coming into the business, making sure it isn't exceeded by money leaving the business. If you plan to work as a financial specialist in a small or medium sized business, cash flow management is likely to be one of your regular responsibilities. In this article, we cover what cash flow management is, why it is important and how it works.

What is cash flow management?

Cashflow management is the process of measuring how much cash comes into and goes out of a business over a set period of time and the methods used to manage that flow to keep a business solvent. A negative cash flow suggests more is going out of your business than coming in, leaving you unable to pay bills or make purchases, while a positive cash flow suggests you have cash available to use as necessary.

Having available funds to meet all your obligations is also called working capital, allowing businesses to identify exactly how much money is at their disposal. The management part refers to the processes and steps involved in keeping track of your cash flow. Frequent statements on a monthly or quarterly basis are common processes for many businesses, while some software provides up-to-date, accurate information about current cash flow on dashboards using automation. Managing cash flow helps businesses understand their financial status, plan for business activities and know when to reduce spending to remain positive.

Related: Operating cash flow: definition, types and benefits

Cash flow vs revenue

Cash flow and revenue give an overview of financial health. Revenue measures how much money is coming into the business as income over a specified amount of time. Cash flow measures what is coming in and going out of your business during the same period, including other sources of cash, such as loans and earned income.

Related: How to calculate net cash flow (and why it's important)

Why is cash flow management important?

Manging cash flow is critical to the running of a business. The financial success of every business depends upon there being more money coming into it than going out. Regularly confirming that cash is flowing through the business and leaving your accounts balanced positively enables key decisions on spending. Some of these key reasons are:

Understanding when cash is available

Having an accurate idea of how much cash is available for use is important for businesses. If a company plans to make a big purchase or invest in new equipment, a cash flow statement provides insight into whether an item purchase is possible from business funds or whether it would be better to seek finance. A clear understanding of cash availability is helpful to determine how much money to spend over a set period. In larger businesses, this information supports the creation of departmental budgets.

Knowing when cash is unavailable to spend

Frequent management of cash flow can also provide insight into when cash can't be spent. For example, if a company is considering investing in an expensive computer system but a cash flow statement shows that insufficient funds are available, this can prevent the purchase to avoid a negative cash flow. While it may sometimes be the right decision to invest based on the return of investment, understanding the cash flow situation enables companies to make informed decisions.

Preventing overspending due to lack of visibility

An unclear idea of business finances can be a key cause of business failure through overspending. If a company doesn't know how much money they are required to spend as a specific figure, it can be easier to overspend without knowing you're going into the negative. Keeping a close eye on cash flow can prevent overspending and encourage thorough investigation before making large purchases that could have an adverse effect on the business.

Keeping track of unpaid invoices

Examining cash flow can provide finance professionals with a secondary way to track unpaid invoices. For example, if cash flow is particularly low over a month or quarter, this can prompt a closer look at invoices that remain unpaid. Managing cash flow regularly and consistently can allow quick problem spotting, such as a regular client not paying for a company's services on time in one month.

Regularly getting an overview of financial health

Financial health is key for all businesses and particularly for small businesses where finances may be tighter. Including cash flow statements as part of regular health checks can help to ensure a business remains solvent. Regularly monitoring financial health enables a business to generate the necessary documents and reports when applying for credit or reporting to stakeholders.

What are cash flow statements?

Cash flow statements report the calculated cash flow of a business. This document is typically created with dedicated accountancy software while some businesses manually calculate their cash flow using spreadsheets. Cash flow statements are a key component in analysing financial health and determining cash flow projects, which can help businesses decide what they can spend and when based on past data.

Related: Examples for cash flow forecast (definition and benefits)

Tips for the management of cash flow

Here are some useful tips to manage cash flow:

Ensure bookkeeping is up to date

The information derived from bookkeeping is integral to creating accurate, up-to-date cash flow reports. Completing bookkeeping to a high standard of accuracy every day or week maintains the overall accuracy of information used to manage cash flow, enabling businesses to make informed decisions. Standardising bookkeeping and making it a regular habit is a good first step to producing high-quality reports.

Generate regular statements for good visibility

As a business changes month to month, so does the cash flow. For example, cash flow in seasonal months may be different from cash flow in months predicted to have low sales. Regular statements can help to build up a complete history of cash flow for the business. This process helps in analysing information and making predictions about future finances to inform business planning.

Decide what changes to make for improved cash flow

As an informative report, cash flow statements can be used as a foundation for change and improvements within a business. For example, a negative cash flow indicates a requirement to balance what's coming into the business against what is going out. Making changes by reducing outgoings can be an effective way to use cash flow, making this calculation helpful for bringing businesses back into positive working capital.

Make it a standard routine

Focusing on cash flow as a monthly report instead of as a response to checking finances after purchase can help to keep businesses out of the negative. Including different financial statements monthly and quarterly can also support other business requirements, such as complying with audits and submitting accurate information for the tax season.

How to improve cash flow

Here's how to improve cash flow:

1. Increase revenue

Increasing the cash into a business can be a practical way to remain financially stable. For example, generating more sales through promotional activities or encouraging purchases with special offers can help to increase revenue over a specific period. Increasing revenue enables businesses to buy expensive materials, stock, services or resources without going into negative cash flow.

Related: What are streams of revenue? (Types, benefits and examples)

2. Reduce payments

Reducing the amount of cash flowing out of the business is another way to improve cash flow. For example, if a business is spending £1,000 per month on coffee beans for their café, finding a supplier who offers the same beans for £750 can reduce overheads by £250 a month. Bills, rent and materials required to run the business are costs which would be monitored to find opportunities to reduce them and improve cash flow over time.

3. Shorten invoice cycles

Businesses can experience difficulties in cash flow based on when clients pay their invoices. For example, if a client has a policy for paying suppliers on 60-day terms, the first month may show poor cash flow while the second shows good cash flow. Shortening invoice cycles to 30 days can be an effective way to maintain stability in cash flow, preventing movement from positive to negative cash flows each month.

Related:

  • What is cash flow and why is it important for businesses?


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