What is cash flow management?

Cash flow management is the process of optimizing the flow of money in and out of a business to achieve a specific operational aim. Effective cash flow management enables businesses to use their working capital better and fuel growth or build resilience.

It involves using several levers, including the approach to accounts payable, accounts receivable, and inventory management, to speed up or slow down the velocity of money entering or leaving the business. With a successful cash flow management strategy, businesses can have more confidence in consistently meeting their ongoing financial obligations while also planning future spend more reliably.

Cash flow management is essential for all types of business – from start-ups to established multi-national corporations. Healthy cash flow is fundamental to broader operational health, ensuring businesses can pay their bills and continue to invest in growth. Without a strong cash flow management strategy, businesses can face cash flow problems that, unchecked, may turn existential.

Cash flow can be positive or negative. Positive cash flow means more money is coming into the business than leaving. Negative cash flow means the opposite. Fundamentally, cash flow management is about ensuring that a state of positive cash flow is maintained at all times.

However, within that general objective, there’s plenty of room for variation in cash flow strategy. Some businesses may prioritize maximizing a cash flow positive position to shore up their balance sheet and build a cash buffer to provide resilience to adverse market conditions. Others may focus on growing revenue as quickly as possible, meaning they’ll tolerate a typically less favorable cash flow position by reinvesting revenue to fuel growth.

Types of cash flow

As the name suggests, cash flow management is the management of cash flow. But cash flow takes several forms. Understanding the different cash flow categories and how they apply to your business is the first step in building an effective cash flow management strategy of your own.

• Cash flows from operations (CFO): Money that flows into and out of the business from normal operations. This comprises operating costs (for raw materials, services, wages, and infrastructure) and revenue (from the sale of final goods or services).
• Cash flows from investing (CFI): Money spent or received due to investment-related activities.
• Cash flows from financing (CFF): Money that enters or leaves the business through financing schemes, including working capital funding and debt repayments.

These three types of cash flow will be of varying importance to different businesses. Cash flows from operations, however, are generally the most significant factor in any business’s overall cash flow.

Challenges in cash flow management

Given how central it is to business operations, it’s no surprise that there are various potential challenges and issues related to cash flow. In fact, more than 80% of businesses that fail do so because of cash flow issues. Understanding what these challenges are is essential in order to adapt to or overcome them.

Slow accounts receivable collection

Selling goods or services is the lifeblood of any business, but collecting revenue quickly is a common challenge. When accounts receivable – the money due to a business in the form of all unpaid invoices sent to customers – are collected too slowly, it can cause significant cash flow issues.

This can be caused by payment terms that are too generous, customers who fail to make timely payments, or inefficient accounts receivable processes.

Poor accounts payable management

Similarly, accounts payable management can factor heavily into cash flow performance. An unoptimized approach to accounts payable management can result in businesses struggling to keep hold of their working capital.

By paying invoices due to their suppliers too quickly or failing to adopt efficiency-breeding accounts payable automation solutions, they can miss out on cash flow-boosting opportunities.

Inventory management inefficiency

Inventory is one of the largest operating costs for many businesses. Accordingly, inventory management is a major factor in cash flow.

There are diverse with unique strengths and weaknesses. Choosing the wrong one can leave businesses with too much working capital tied up in inventory that they sell too slowly. Alternatively, they may have too little inventory on-hand to meet demand, missing out on potential sales.

Cash forecasting difficulties

The ability to accurately forecast future cash flow, referring to both income and outgoings, is highly valuable in managing cash flow in the present. This is particularly true for businesses that operate in cyclical or seasonal markets, where demand fluctuates significantly throughout the year.

With poor cash forecasting capabilities, businesses can struggle to prepare for the months or years ahead, leaving themselves with too little cash to cover unexpected expenses or too much, implying that they could have deployed it to greater effect earlier.

How to improve cash flow management

Whether directly facing one of the above challenges or not, businesses seeking to improve their cash flow position have several routes available.

Strengthen cash forecasting abilities

Improving the accuracy of cash flow forecasts can greatly help cash flow management. With a better understanding of how cash flow will change in the future, businesses can adopt a cash position that prepares them to make the most of the situation.

Technology can play a major role in facilitating better cash forecasting. Using a dedicated cash forecasting solution to run multiple scenario-based cash flow projections means businesses can move forward confident that they’re not heading toward danger. This also means they can confidently make better use of working capital that they otherwise would have preserved to build resilience.

Shorten the cash conversion cycle

The cash conversion cycle is a metric that measures how long it takes a business to convert cash into inventory and back into cash again. It’s calculated using a formula containing three inputs (days payable outstanding (DPO), days sales outstanding (DSO), and days inventory outstanding (DIO)), and improving performance in any one of those three inputs will shorten the cash conversion cycle.

DPO and DSO can be optimized by improving accounts payable and accounts receivable performance, respectively. DIO can be optimized through new approaches to inventory, including prioritizing and reducing slow-selling inventory stockpiles.

Review inventory management strategy

Finally, businesses can use inventory management strategies to their advantage, adopting an approach to inventory that suits their cash flow aims. By increasing or decreasing the amount of inventory and how it’s held, businesses can manage how much of their cash is held up in stock.

For businesses looking to strengthen their cash position in the short term, this might involve reducing the amount of safety stock kept on hand, at the risk of missing sales if demand increases. For others more concerned with long-term resilience, accepting the cash flow hit by keeping safety stocks might take priority.