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.