What Is Cash Flow Management?

By Author: Tiffany Wright
Total Articles: 4
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What is cash flow management? Cash flow management simply is analyzing and ensuring that your cash inflows surpass your cash outflows at any given time. This is the essential essence of cash flow management. In more detail, cash flow management is the process of tracking, analyzing, and adjusting your company's cash flows. Cash flow is NOT income. You can have high income but negative cash flow.

First, analyze your cash flows. Then devise and implement cash management strategies.

To illustrate this and make it more simple, let me provide you with an example. Let's assume you enter into a $200,000 contract to provide marketing services over a period of 6 months. Your revenue the previous year was $1,000,000. So that contract provides 20% of the previous year's revenue. According to the contract you submit invoices once per month (fairly standard in corporate contracts) on the 30th and the corporate customer has 30 days to pay you. Your firm starts fulfilling the contract on February 1.

Fortunately, with a non-retail or wholesale service business - except for construction and other materials-heavy business ...
... lines - there is typically minimal cost incurred before the contract commences. The major cost is personnel costs and overhead allocation, although travel and related expenses may also accrue. However, once you start fulfilling the contract, you incur employee costs that will not be paid for 30-60 days.

Let's say you'll make a gross profit of 60% and an operating profit of 30%. Assuming the revenues and profits are booked on a monthly basis, the monthly revenue would be$33,333; gross profit, $20,000; and operating profit, $10,000. Also assume that your only cost of goods sold/cost of services provided is personnel, who are paid twice per month, on the 15th and 30th. If you do not book any advance payments, here is a table comparing the cash flow on the contract to the operating income:

Revenue Op. Income Cash Flow
End of Week 2 (day 15) $16,667 $5,000 -$6,667
End of Week 4 (day 30) $33,333 $10,000 -$13,333
End of Week 6 (day 45) $50,000 $15,000 -$20,000
End of Week 8 (day 60) $66,666 $20,000 $40,000

This negative cash flow or, put another way, cash flow shortage, continues for four to eight weeks until you receive your first check of $66,666 for the project at the end of the 8th week (day 60). Upon payment your cash shortfall disappears and you actually end up with a cash surplus due to your high gross and operating margins. However, the cash flow will go negative again in another 15 days when employees on the project are paid again.

The longer your company's invoices remain outstanding, the higher the average balance of your accounts receivables will be. This is cash that would be used to pay your employees and operate your business. The dramatic improvement in positive cash flow that occurs when the average collection period is shortened surprises many people. Follow the example below for illustration purposes.

In our above example, there is an average collection time of 30 days so the accounts receivables average $33,333 for this 6-month project. Multiply this by 2.5x for annual revenue of $1 Million (equals $2,778 in average revenue per day) gets you $83,333. Reducing this collection period by 5 days will free up $13,889 in operational cash flow.

To shorten the time your accounts receivables are outstanding you can do the following:
offer early payment discounts to encourage companies to pay early
structure contracts to say payment upon receipt of invoice or net 15
invoice on the 15th and 30th, to better match the timing of cash inflows with cash outflows
obtain a deposit for services rendered or a partial payment in advance. (This doesn't reduce your accounts receivables but reduces the amount of the invoice converted to a receivable.)

We have all heard of companies who went bankrupt when on a fast growth trajectory. This is why. They book revenue at a rate multiples higher than the previous year but they don't have positive operational cash flow. And they don't have the financing to cover the gap in operational cash flow. This unplanned cash flow shortage is one of the primary reasons companies go out of business. If you do not have overlapping jobs with payments coming in that can cover the cash flow shortage, your business is hurting. You must engage in budget planning and analysis before each and every project in order to properly practice cash flow management and plan your cash needs accordingly.

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Tiffany Wright is the author of Help! I Need Money for My Business Now!!, an ebook that shows how to raise capital, available at http://www.moneytogrowbusiness.com.She is a business owner and turnaround consultant who has helped raise $31 Million.