If you could receive customer payments faster, how would your business improve? Many small businesses struggle with cash collections, and finding enough cash to operate each month can be a challenge. Speeding up cash collections, even by a day or two, can have a meaningful impact on your financials. Use these tips to understand your cash inflows and outflows, and the steps you can take to improve your cash management, including the use of technology to receive payments faster.
Where your cash goes
It’s a common problem. A business owner starts the year with a positive cash balance and generates a profit for the year. However, when the owner checks the bank balance at the end of the year, the ending cash balance is lower than where the company started. Where did the cash go?
Accounts receivable and inventory accounts can tie up a large amount of cash, and even a profitable company can struggle to collect these dollar amounts. When the cash does come in, you have to satisfy accounts payable.
This balance represents the dollar amount of credit sales that are not collected in cash, in short, it is the money you are owed. Adding new customers may cause accounts receivable to increase quickly, which can lead to a cash shortage. Assume you generate $1 million in credit sales, and the average customer pays in 30 days. Now you increase credit sales to $1.2 million in 2018, but the average customer pays in 45 days.
In most cases, accounts receivable increases, because the new customers pay more slowly, on average. While your business generates $100,000 in credit sales per month in 2018, it took 15 more days, on average, for customers to pay.
The growing accounts receivable balance means that cash inflows are slower, and you may not be able to generate sufficient cash to operate each month. Increasing credit sales also means higher costs, and you need cash to pay for the higher costs.
As sales increase, so will the dollar of inventory needed to fill customer orders. If your firm is growing, you may be spending more on inventory each month, which can also lead to a cash shortage. To maintain a sufficient level of cash, business owners must keep an eye on the accounts receivable and inventory balances, and take steps to limit the dollars tied up in these accounts.
Business owners also need cash to make payroll, pay vendors, and possibly for debt payments. Your accounts payable balance represents bills you must pay within 12 months, and that balance is a current liability. If cash inflows are insufficient, you may need to access a line of credit or raise more capital through a stock or bond offering.
Current vs. Non-Current
Assets and liabilities are either current or non-current, and these classifications have a big impact on cash management. A current asset represents cash, or an asset that will be converted into cash within 12 months. Accounts receivable balances and inventory are current assets.
On the other hand, fixed assets, such as machinery and equipment, are non-current assets that will be used for years. The most pressing cash management need for a business owner is to collect current assets in cash so that current liabilities can be paid. Planning your long-term cash needs is important, but you need to address any short-term cash problems now, in order to keep your doors open.
Now that we’ve discussed the parts of cash management lets talk about ways to improve it. Here are some strategies to improve cash flow management.
How to get paid
The big “users” of cash in your business are accounts receivable and inventory, and you can use these strategies to collect cash faster:
Enforce a formal collection policy to manage your accounts receivable balance. Your accounting software should provide an ageing schedule for accounts receivable, which groups your receivables based on when each invoice was issued. You should monitor this report and implement a collections process to email and possibly call clients to ask for payment.
Offer customers a discount, if they pay an invoice within 10 days. Sure, you’ll collect slightly less cash, but some customers will pay faster, which improves your cash inflows.
If you offer customers a 5% discount if they pay within 10 days of receiving the invoice. You may lose 5% of the revenue generated, but collecting cash sooner may eliminate the need to borrow money- and pay interest costs.
Managing inventory is a balancing act. If your business is manufacturing, you may keep a supply of finished items on hand as inventory. Carrying an inventory balance allows you to quickly fill orders so that clients don’t have to wait. But you want to minimise the dollars tied up in inventory, while making sure not to lose a potential sale.
Smart inventory management requires time and effort. You will need to analyse the dollar amount of inventory carried in past years, the sales generated, and the number of sales lost due to a stockout (when an inventory item is out of stock). This analysis can help estimate the dollar amount of inventory needed.
Another tip for inventory management; develop a strong relationship with your largest customers. Understanding the future needs of your biggest clients allows you to preplan your own inventory needs.
Every business should use technology to collect cash faster, including software tools that speed up the time it takes to transfer payments into the company bank account. If you can speed up cash inflows by just a few days, you can dramatically improve your cash position.
Worth the effort
Improving your cash management system requires time and effort, but your work will pay off. Use these tips to forecast your cash needs, speed up cash collections, and avoid borrowing money to operate your business.