A crucial skill for any business owner is knowing how to budget and manage the inflow and outflow of cash to fund the operations of the company.
What is cashflow?
Cashflow can be defined as the inflow and outflow of cash and cash equivalents during a specific time period from a company's financial statements. The ability of your company to make timely payments to employees, vendors, taxes, and other operating expenses is known as positive cash flow.
Importance of budgeting and managing cashflow
Budgeting and managing inflow and outflow are crucial for a business to survive as it helps determine the business working capital requirement (WCR).
Working capital is the lifeblood of any company and can be calculated as accounts receivable (sales made but not yet paid for) + inventory – accounts payable (purchases bought but not yet paid for).
WCR, which is linked to the operating cycle of a business, is the difference between the cyclical requirements and the cyclical resources of a business. It stems from the gap between sales, income, purchases, and expenses.
The following recommended steps will guide you to budget and manage the inflow and outflow of cash in your business.
Create a cashflow budget – In order to do this, you must compute your anticipated future revenue and expenditures utilising your historical financial performance, market trends, and business goals. By doing this, you can budget and anticipate your cashflow, and alter your strategy. You may anticipate your cashflow using a variety of tools and methods, including spreadsheets, accounting software, and financial models.
Make the cashflow budget realistic – Some businesses make the error of developing an inflated budget in an effort to seem larger or show development. Market trends and historical financial performance are taken into account when making a forecast. You should be able to determine the most appropriate and manageable budget for your company after reviewing and conducting research. Reaching for the skies is fine, but a company's financial success is determined by statistics and graphs, not emotions.
Know the cash conversion cycle – Also known as the cash cycle or net operating cycle, the cash conversion cycle is the time it takes for a business to convert its stock or inventory into cash flows from sales. The process also involves where a business purchases inventory or stock, sells the goods on credit, and then collects payments from customers who made credit purchases as part of the cash conversion cycle. Every business leader has to understand the cash conversion cycle since it is a critical measure. The method by which a business funds the purchase of its products, the conditions (credit terms and collection period) under which it accepts payments from customers, and the time it takes to receive payment from those sales all affect the cash conversion cycle time.
Monitor your cash flow performance – This entails contrasting your actual performance with what was previously predicted and anticipated. By monitoring and analysing your cashflow budget, you may identify any deviations, inconsistencies, or issues that may arise, such as unanticipated costs and payment delays, and take the necessary action. Various methods and indicators, including cash flow statements, income statements, balance sheets and key performance indicators may be used to monitor your cashflow budget.
Improve your cash flow performance – The final item on your to-do list after predicting and monitoring your cashflow budget is to fix any small issues and discrepancies you found during the monitoring phase. This can be done by negotiating better terms with customers and suppliers, reducing expenses, managing working capital and debt, creating a contingency plan, increasing sales, and all of the above. In order to maximise the performance of your budget and cash flow, you must go through this procedure. Doing so will improve your financial stability, profitability, and growth.
Any business must effectively manage its cashflow budget. It is a practice that all business owners ought to implement as a business can weather approaching storms and establish the foundation for long-term success if it has cash on hand and sound financial strategies in place and predicted.
If you require advice and support with budgeting and managing cashflow effectively, please email our finance experts at enquiries@ovacgroup.com