Three tips towards good cash flow management

Small businesses may have a tough year ahead after recent ASIC figures reveal that insolvencies have reached a record high in 2011, particularly for SMEs in the services and construction industries.

Small businesses (20 employees or less) have accounted for 78 percent of companies entering external administration last year and there are concerns that 2012 may shape up to be a similar year.

One of the primary reasons for failure was reported as inadequate cash flow use, with over 40 percent of businesses falling into this category. As this has consistently been the case over the past three years, there can be no doubt that good cash flow management is vital to the health of a business.

With these insolvency figures in mind, here are three tips towards a sound cash flow management strategy.

  • Know your balance sheet
  • Invoice regularly
  • Develop a cash flow forecast

Know your balance sheet

One of the reasons why many businesses fail within the first two years of their inception is because their owners may not necessarily have a working knowledge of how to run a business. Most SME owners are focused on the day to day operations such as selling a product or service, and not 'back end' duties such as budgeting, credit management, taxation and other accounting needs.

Even if you may not be familiar with terms such as 'breakeven analysis' or 'angel investing', you should know what a balance sheet is. It is a statement of your business's assets (what you own) and liabilities (what you owe) as well as your net worth, according to the Small Business Development Corporation of WA.

Knowing exactly what each item on your balance sheet stands for is the key to determining the trends and capabilities of your business. Although preparing and lodging a balance sheet with your tax return is not compulsory for sole traders and partnerships, it is good practice to do so as it paints a realistic picture of your financial position.

However, there are some things a balance sheet does not tell you including accounts payable, receivable, inventory and work in progress. Most people assume that as long as they are making a good profit, the business is in the black- but not so.

It is important to also look at your accounts receivable records as the customers you have extended credit to may not have paid their bills yet, even though you may have already factored their payments into your balance sheet.

Invoice regularly

In order to avoid cash receipts lagging behind cash payments, as described above, it is important to invoice your customers after every project instead of once a month. This will ensure that you have more available cash to spend on capital or to pay suppliers.

According to business management expert Leon Gettler, if you have a good relationship with your customers, it may be a good idea to suggest an upfront payment (such as 40 percent) and the rest when the project is completed.

Another alternative he suggests is to stagger payments across the length of the project, which often occurs in the construction industry, or provide discounts for early payers.

Develop a cash flow forecast

A cash flow forecast can help small businesses keep track of their accounts receivable and accounts payable. It acts as a short term and long term planning tool that can help you determine when your periods of high expenses are, in order to budget accordingly.

While most businesses may already have a cash flow forecast, it is imperative that it is updated at regular intervals in accordance with business strategies and goals. For instance, if you intend to purchase an additional office space in the next year, you should ensure that your business has enough capital to do so to avoid borrowing additional funds or selling existing assets to cover debts.

You can read more about cash flow forecasting here.

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