Importance of Cash Flow in a Business and How to Manage It Effectively

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cash flow

Proper management and planning of resources are two fundamental elements for companies to have good financial health. The importance of cash flow is highlighted here since its management can affect economic stability, growth, and the overall direction of the company.

In this sense, it is key to constantly control and monitor cash flow to avoid crises or reaching a point of bankruptcy. Finding out exactly what money is coming in and going out can drain resources and lead to mismanagement.

What is the importance of cash flow in a Business?

First and foremost, this financial report is one of the leading indicators of a company’s liquidity, which is why it enables you to make the best judgments possible when faced with a variety of issues, such as:

  1. Figuring out if the company can continue to grant credits
  2. Deciding that whether the company should shorten payment terms or not
  3. Amount of required merchandise
  4. Can they meet the obligations or debts on time?
  5. Checking whether it is necessary to request an extension of payment to providers
  6. Do the company require more finances?
  7. How to make new investments?

The cash flow facilitates economic decision-making and setting priorities for different situations, and anticipates any financial problem.

Having a broader perspective of the company’s economic situation allows one to know its actual financial health. It also helps to know if it is in tune with what is expected or, if it is necessary to make adjustments in certain aspects.

Cash flow makes it possible to anticipate strategies like accelerating debt collection, better management of accounts receivable, reducing expenses, and to name a few. In the face of a potential deficit or lack of money, avoiding great risks that could risk the operations of a business.

Furthermore, the importance of cash flow in businesses has a lot to do with optimizing capital distribution in order to maintain a strong financial structure capable of paying all obligations and, of course, ensuring long-term growth.

Reasons why Businesses run out of cash and how to avoid 

These are the main reasons why companies run out of cash flow:

  1. High production and/or maintenance costs without a medium and long-term strategy.
  2. Not offering benefits (discount) for advance payments or giving them the option to make payments in installments.
  3. Not providing convenient payment methods.
  4. Their accounts receivable are paid in 30, 60, 90, and sometimes it takes more days.
  5. Depending on few clients.
  6. Not scheduling payments.
  7. Not consider the cost of factoring or other financing alternatives within their budgets.
  8. They have customers who are bad payers.

We can summarize these reasons in five common bad practices of cash flow in an SME

  1. Not setting the price of the service or product well and not calculating the costs well.
  2. Not controlling administration and sales expenses.
  3. Prioritizing sales over collections.
  4. Not adapting to market changes.

How to avoid liquidity problems?

As you can see, liquidity is essential for every business, and it is the main source of constant cash flow. Here are some of the tips for maintaining a good balance of your cash:

Keeping a track of accounts receivable

If pending payments from clients are not collected on time, it can cause a big liquidity concern.

Making cash flow projections

This will allow you to assess different situations and execute the best tactics, but remember to be realistic while forecasting!

Efficiently manage the stock of products

You’ll know what you truly need to acquire if you keep track of your product inventory well. Because this may have an impact on the company’s cash flow.

• Evaluate each of the company’s expenses.

Adopt the right Software

There are many systems or software that help optimize operations that can completely control purchases and sales. This makes it easier for you to make the cash flow report or even calculate it automatically.

According to the company’s needs to maintain a healthy or positive cash flow, you can also implement other tools or strategies.

Carrying out this exercise allows the business to remain operational. Also, helps to avoid possible bankruptcy, meet objectives, and have a clear vision of the actual financial health to act on time.

Still wondering if there are other solutions?

You are right; if you get less time to manage cash flow and other business financial aspects, you may take advantage of outsourced finance and accounting services.

Firms offering these services usually have service rates lower than you would be paying to your in-house accountants.

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