Cash flow is governed and influenced by three main aspects of the business – how much money is coming in, how much money is going out, and how much capital the business can access to carry it through periods of trading difficulty.
These fall into three business areas:
- Accounts receivable
- Accounts payable
- Access to capital
Accounts Receivable – reasons for poor cash flow
Accounts Receivable refers to how much money is coming in to the business – the money owed to a company by its customers and other debtors.
Obviously, the amount of money coming into the business has a major impact on cash flow. It's here that small to medium-sized businesses find the greatest challenges – and make the biggest mistakes. Leaving aside general business practices such as generating revenue from sales, getting paid for work done is a big problem. For example, many companies:
- fail to negotiate firm payment terms in advance
- fail to demand payment for milestones (especially for project work)
- fail to bill up-front where appropriate, such as for materials costs
- fail to invoice promptly
- fail to include all the necessary information on invoices
- fail to chase late payers effectively
- fail to maintain the mindset that they deserve to be paid
All of these factors can dramatically affect the flow of money coming into the business. See Chapter 4 of this guide for practical advice for optimising your accounts receivable processes.
“Timing is often a huge part of cash flow limitations, paying for expenses upfront but not receiving payment until the transaction has passed.” - Kylie Parker, Lotus Accountants
Accounts Payable – causes of poor cash flow
Accounts payable is the money flowing out of the business – the money owed by the company to its suppliers and other creditors.
This is just as important as accounts receivable, but not always considered so carefully by business owners. If money flows out of the business faster than it's coming in, problems are likely to ensue. Some business owners:
- fail to put enough money aside to cover taxes (e.g. VAT or GST)
- fail to forecast and budget for their future costs effectively
- fail to budget properly for materials costs and fixed costs on client projects
- fail to negotiate favourable payment terms with suppliers
“You might end up in a situation where you've got to pay your bills, but with what money? Your customers haven't paid you yet! You've given 30 days to your customers but your suppliers want to be paid within 14 days. You're being pursued for money before having been paid yourself. Lots of businesses fall into this trap.” - Ben Nacca, Cone Accounting
There's a balance to maintain here. Paying suppliers too soon can affect cash flow, but paying out too slowly can make your suppliers reluctant to deal with you in future. It can also affect your reputation, which may encourage other suppliers to steer clear. See Chapter 4 of this guide for practical advice for managing your accounts payable.
Access to Capital – a backstop for poor cash flow
Capital refers to money that's available for the business, money that isn't bound to day-to-day operations. Capital can exist as loans, equity, free cash and other forms.
If a business can tap into hard cash when it needs to bridge a gap between revenue and costs, that may be enough to carry it through temporary tough times. To return to the lake analogy, having access to capital is like being able to make it rain at will. If the water level gets too low, you can top it up.
There are consequences to this, of course: capital doesn't come for free. Some small business owners inject capital from personal assets, such as mortgages on private property, which can lead to greater personal expense and also greater stress. Capital from investors usually means giving up some equity in the business, now or in the future. Loans must inevitably be paid back with interest.‹ View table of contents Next page ›