The five stages of your cash flow cycle

Darrell Lea's recent collapse has called attention to the importance of understanding and managing your cash flow to stay afloat in these difficult times. For small businesses that are starting out in particular, poor cash flow management can make or break your business cycle, so it's important to understand how the cash flow cycle works to ensure you stay on top of the money going in and out.

According to Commonwealth Bank, every dollar you invest goes through the cash flow cycle before it comes back to you, bringing some profit with it. The faster the cycle turns, the more successful your business will be.

Below, we take you through the five different stages of accessing and managing your business accounts.

cash flow cycle

Stage 1: Payment received

Most new business owners are familiar with this stage, as it means that they are getting an instant cash boost for goods and services provided to customers.

However, this doesn't have to be limited to cash payments - your business should be open to other methods such as debit or credit cards, e-commerce, PayPal, cheques, direct deposit or over the phone.

Having more than one way of accepting payment provides customers with more choice, flexibility and can turn one-off customers into regular ones.

However, if you're offering products on credit, ensure that you take precautions as it means you won't receive payment straightaway. For more information, read �Determining your level of risk when extending credit'. Also be aware of merchant fees that banks and PayPal charge for processing payments, as you may not process enough transactions initially to make the fees worthwhile.

Stage 2: Manage your cash

The next step is to manage the cash that you have just received, as the days of storing your hard-earned money in a box under the counter are long gone. Managing your cash, or liquidity, is different from being profitable - a business can still fail because of a lack of cash even though it's making profits. Find out the difference between profit and liquidity here.

There are many ways to make surplus cash work for you, depending on your needs. If you want regular access to your funds but still want to earn interest, consider a basic business bank account, which can also come with credit cards and cheque books. If you want to invest the money to build long-term wealth, you could put your money in a term deposit. If there are suppliers to pay or equipment to invest in, you can also funnel your money through these avenues, but ensure that you have enough left over to cover operational costs.

Stage 3: Make your payments

This brings us to the next step of paying your staff and suppliers, which should be done within 30 days of an invoice being issued. Paying on time can not only help maintain your suppliers' cash flow but can also avoid getting a black mark on your credit file. For everyday expenses such as accounting fees, office supplies, insurance, utilities, building management, travel, vehicle, salary and marketing costs, you may want to use a credit card as it allows you to make payments easily, track expenses and maintain a good business credit history.

If you find you can't pay all your creditors, here are some tips  to help you. Consider online business banking as a method of paying your staff, or, when you grow bigger, implementing a complete payroll system.

Stage 4: Finance your purchases

If you've paid on credit, you won't have to come up with the money until next month, but you should always think about how you will be funding your purchases. Ensure you have a budget and forecasting tool to tell you how much money is owed to you and how much you owe others, and when these amounts are due. If you have enough money in your business savings account to cover everything, that's good news but more often than not, SMEs struggle to turn over that much money in their first year of operation. This is when you might want to look at getting a loan from a bank  or a government grant, or even getting an investor on board.

Stage 5: Inventory control

Now that you've received and made your payments, it's time to start thinking about your inventory levels and how you're going to manage it. If stock levels exceed customer demand, this can hurt your business as each unit of unsold stock represents money that is tied up and cannot be used to pay your bills or to re-invest. Commonwealth Bank advises that you turn over excess stock, even at a discount, in order to get more cash back into your business quicker. Ensure that your suppliers are reliable as this can affect stock delivery times and levels.

Stock can also refer to vehicles, plants or equipment. To avoid tying up your money in these areas, consider renting IT systems, computers or vehicles as it may be cheaper.

Summing it all up...

The cash flow cycle is extremely crucial to the health of any business, small or large, and a failure to properly manage your money at any of the five stages can severely affect a firm's ability to remain operational. In the current climate, in particular, letting accounts receivable and accounts payables slip could be the tipping point between a solid, functioning operation and one that slides into irreversible difficulty.

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