Cash Flow 101: Introduction to Managing Cash Flow Cycle

Managing Cash Flow Cycle – 101

In times of economic downturn, the importance of cash flow management comes into even sharper relief. When times are lean, accessing money from banks and other lenders becomes much harder. With heightened wariness of bad investments, lenders are not only more reticent to lend but also impose much harsher, costly repayment conditions.

Like the blood flowing through a body, efficient, planned cash flow is the lifeblood of any well-run business. It is vital to the current and future health of a business to have a working cash flow model.

Ensuring that all facets of the business’s assets flow and balance just as they should is an important skill for any time – whether things are good or bad.

Controlling Cash Flow

Cash flow, at the base level, boils down to the movement of money coming into and leaving a business – hence its name.

However, cash flow is not about the profit and loss of a business, as this takes into account many other deductions and additions. It is best to think of cash flow as the continuous pumping of blood about the body, keeping everything healthy and balanced.

Cash flow, if it goes awry, can have quick and devastating results on the business as a whole, just as lack of blood flow to the brain can. This is why it is important to keep a constant handle on cash flow, with monitoring and adjustments made as needed. Cash flow is not something that a business sets up and leaves alone. It is something that needs control and direction to provide the most benefits.

  • The flow of cash in a business requires tracking and control. Any time these mechanisms go awry, cash will quickly find its way out of a business. It pays to think of cash an animal that needs wrangling to get the most out of it
  • Many businesses, with the best products and services, have gone under because they did not understand how to manage their cash flow. Cash flow management is not an aside or an afterthought – it is as important, if not more so, than most other aspects of running a business.
  • To manage cash flow effectively, a business must know everything about its own commitments and incomings and as much as possible about how customers’ creditworthiness and history will affect the business.

This includes things like:-

  • Customer record of payment reliability and overall creditworthiness
  • Debt terms and facilities including maturity
  • Payment arrangements and terms of suppliers
  • Long-term forecast for the business and cash flow
  • Managing cash flow well is a real skill. It takes time to learn the ins and outs and master.

The Cycle

The ideal structure for a business with a good cash flow model is a cyclical one, with an ongoing model that undergoes tweaks and modifications as necessary.

A simple cash flow cycle:-

  • The business buys resources with cash
  • These resources become a service or product
  • The service or product is sold to customers
  • The business takes payment for these products (sometimes in short order, sometimes delayed)
  • This cash goes toward buying more resources, and thus the cycle continues

The idea is to build the amount of resources bought over time, with more goods/services produced and more money accrued until, hopefully, the business grows.

As seen above, cash flow relies on a number of factors and processes working together to make the cycle a complete one. If one part of the cycle malfunctions, then the cycle breaks down.

In order to keep this cycle working, the business has to closely monitor and control every step. This can mean being aware of a wide variety of potential hiccups and eventualities in inflows and outflows.

Below outlines the various ways that cash flows in and out of the business.

Cash Inflows – Money flowing into the business:-

  • Outstanding customer accounts from sales
  • Sales of goods/services to customers
  • Interest from investments
  • Shareholder investment
  • Bank loans

Cash Outflows – Money leaving the business

  • Operating expenses – advertising, rent, materials, other overheads
  • Wages
  • Purchasing goods/resources to sell on
  • Interest and principal on loans
  • Taxes

As said at the top of this article, cash flow is simply balancing the money that comes into a business with the money going out. Whilst that sounds simple, the above information should reveal that it is not always so.

A simple misstep can have big consequences for cash flow and, by extension, the business. When outflow outstrips inflow and has a cash flow gap. The longer this continues, the worse it becomes.

The ideal is to gradually accrue more inflow than outflow, enabling the business to grow. This means planning far ahead as well as appraising the current situation.

Effective cash flow management takes time to learn and even longer to master. However, once implemented properly, strong, balanced cash flow can give any business a rock-solid foundation for future success.

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