Uncertainty is ever-present in business, particularly when it comes to your cash flow. Your business can be profitable, viable and perfectly healthy, but if your cash inflows suddenly shrink or your outflows increase, you can quickly be in trouble.
In this article, we’ll look at the potential impact of cash flow risk and discuss some of the steps you can take to manage it.
What is cash flow risk management?
Cash flow is not just a figure on your balance sheet - it’s a process that refers to the money that comes into and goes out of your business every day. This is the money you use to cover your day-to-day expenses, such as paying your bills, staff and suppliers.
Cash flow is inherently risky because obstacles such as late payments from customers and seasonal sales fluctuations can stem the flow of money into the business. Similarly, unexpected expenses such as machinery repair bills or supplier cost increases can squeeze the cash that’s available to pay your bills.
Cash flow risk management is the term that describes your ability to identify and assess the various risks to your cash flow and put strategies in place to help you overcome them. By planning for the unexpected, you can reduce the likelihood of cash flow shocks and keep your business running smoothly.
Why is cash flow risk management important?
Profits are not the same as cash. The two are certainly connected but they also act independently. You can have a business that generates a healthy profit, but if it suffers from negative cash flow then it will struggle to operate and could even be at risk of failure. That is why investors, lenders and other creditors regard long-term positive cash as an indicator of a business’s stability and creditworthiness.
Effective cash flow risk management is important because it allows you to identify and minimise the risks that could affect your business’s ability to meet your financial obligations. It also provides peace of mind, makes your business more attractive to investors and lenders and gives you the confidence to invest in and grow your business.
What steps can you take to improve your cash flow risk management?
You need to have a clear plan if you want to reduce the overall risks associated with your cash flow. Fortunately, there are some relatively simple steps you can take.
1. Credit check new business customers
Performing credit checks on all your new customers will help you understand how much credit you can offer, give you more information about their payment history and reduce the likelihood of bad debts. Crucially, thorough credit checks that are provided by industry experts such as business information providers and credit reference agencies, can also help to reduce late payments, which are a leading cause of cash flow shortfalls, particularly among smaller businesses.
2. Speed up your cash inflows
There are several things you can do to encourage your customers to pay their invoices more quickly. Promptly issuing and following up on invoices is an important first step. You can also offer early payment incentives on your discounts, such as a 2% discount on payments made within 7 days. Giving your customers lots of different ways to make a payment can also be effective.
As well as incentivising your customers to pay quickly, you should also have clear penalties for those who pay late. Making late payment charges clear on the invoice and chasing outstanding payments immediately can help to avoid cash flow concerns.
3. Understand your finance options
Some finance products are designed specifically to help businesses improve their cash flow position. For example, working capital loans can be a quick way to raise money that you need to meet the everyday costs of the business.
Invoice finance is perhaps a more sustainable way to increase cash flow as no monthly loan repayments are involved. Instead, you effectively sell an unpaid invoice to a finance provider. They typically pay you 80-90% of the invoice’s value upfront. You’ll then receive the balance - minus the finance provider’s fee - when your customer pays the invoice.
4. Manage stock levels carefully
One of the leading causes of cash flow shortfalls is overstocking, which increases the amount of cash you have locked up in your inventory. Managing your stock levels more effectively and working with suppliers to reduce supply chain lead times can keep more cash in your bank account.
Keep your business thriving
Your cash flow might be running at a healthy stream now, but with prevalent late payments, defaults and other threats, it’s well worth implementing some of these simple steps to help you manage the risks. As well as improving your ability to pay your expenses, positive cash flows can also strengthen your business in the minds of investors and lenders.
*About the Author
Jon Munnery is an insolvency and company restructuring expert at UK Liquidators, a leading provider of company liquidation services to both solvent and insolvent limited companies.
Jon supports businesses at risk of insolvency and already insolvent as a result of creditor pressure and the build-up of business debts.