Systematic cash flow management is one of the most important prerequisites for the day-to-day operation of a company and the achievement of long-term goals. When cash flows are insufficient, this is immediately reflected in the company’s finances – there are difficulties in paying the invoices of supplies or taxes. The company’s growth is also slowing down. Part III of the series of reporting posts is about which reports to use for cash flow management and how to manage cash flows in a way that supports the development of the company, not hinders it.

The goal – to obtain control over cash flows

When talking about cash flows, we should first start with the fundamental difference between cash and profit and which transactions affect one or the other. 

Profit is accrued income minus accrued expenses, including the costs of goods sold.

Cash is all cash income minus cash expenses.

Which transactions affect profit/cash: 

 

	profit	cash
value-added tax	NO	YES
taking loans and repayments	NO	YES
purchase of fixed assets	NO	YES
purchase of goods to warehouse	NO	YES
depreciation of goods from warehouse (including sales)	YES	NO
depreciation of fixed assets	YES	NO
cost capitalization	YES	NO
vacation reserve	YES	NO
asset write-downs	YES	NO
estimated costs and benefits	YES	NO

The cash flow depends on

• how quickly customers pay you
• how long payment terms have been given to you by your suppliers
• amount of loan payments 
• amount of fixed asset purchases

• amount of cash withdrawn from the company by the owner (spent for own use, e.g. expensive trainings, car).

Profits are accounted for on an accrual basis, by involving a number of options. Therefore, the result of the income statement can be much easier influenced. Profits are affected by, among other things:

• limit of fixed assets – i.e. to what price the fixed assets are expensed and when they are recorded in the balance sheet
• determination of the life of fixed assets, i.e. the number of years within fixed assets are expensed
• capitalization or depreciation of development costs
• establishing of various reserves – these enable to reduce (and further increase) profits, if required
• write-down of receivables, inventory and investments – based on conservative approach.

Identify problem areas

If the importance of cash flow management is underestimated, a completely profitable company can also go bankrupt due to lack of cash. To avoid the tense situation, ask your accountant to prepare a cash flow statement for the previous two years and the last months separately, and identify the problem areas. Some of the most common problems to deal with:

Customers do not pay their invoices on time

Poor process for managing outstanding invoices results in too lengthy period of receipt of claims and your money is stuck under the latter. These could remain outstanding as well.

What to do?

You should have proper credit policy – how to assess potential customers to whom credit can be sold and what to do, if invoices remain outstanding.

Payment terms for purchase invoices are too short

If in case of sales invoices you had to deal with receiving the invoices as soon as possible, then here it is vice versa – try to get the longest possible payment terms.

What to do?

Review the payment terms of your suppliers, it is often possible to negotiate and get longer payment terms. Note that here you have to be active yourself, no one will offer you longer deadlines on the tray. Ask the accountant to pay the invoices on time, not earlier.

Too much inventories

Too much inventories means a full warehouse but an empty bank account. The same applies to the service provider if you have not submitted invoices for a large amount of work (work in progress).

What to do?

Review your inventory ordering and inventory management system, assess the level of inventories reasonable for your company. As a service provider, consider whether it is possible to divide long-term work into logical pieces and submit invoices in parts, rather than finally at a time.

The management of sales invoices, purchase invoices and inventory processes together is called working capital management. When a company grows rapidly, receivables (and inventories) often grow very quickly and the company needs additional financing to offset it.

You can read more about the calculation of the company’s working capital cycle and the need for additional financing in the article – what is working capital and why is it important.

Inappropriate loan and equity structure

It is often possible to significantly improve cash flows by reviewing the existing loan agreements. Maybe loans should be consolidated? And pay back in the long run?

Sometimes the main reason for the tight cash flows can be the owner who has taken too much money out of the company. Maybe it would be worth reducing the amount of dividends to be paid? Or add the owner’s money to the company instead, by increasing the equity?

Fixed assets are financed on account of the loans and equity, so all important purchases of fixed assets should be planned in advance and suitable financing should be found for these.

What reports do you need to manage your cash flows?

To manage cash flows, ask the accountant for the following reports:

• short income statement
• short balance sheet – by highlighting the lines to be dealt with (e.g. receivables or inventories)
• balance sheet ratios (e.g. average receivables in days or inventory flow rate)
• cash flow statement compared to the cash flow budget.

These reports help you gain more control over your company’s cash flow management and identify problem areas that need to be addressed. If you need additional tips to improve your cash flows, then also read this article: 7 ways to improve your cash flows + 50 additional tips for better cash flow management.