Last editedNov 20223 min read
As cash flows in and out of your business each day, it’s important to track and manage it carefully. Without keeping an eye on earnings and expenses, you might find your wallet empty when it’s time to pay the bills. Cash flow risk describes the danger of running on empty. We’ll discuss how to reduce these risks and take control over cash flow in this guide.
Cash flow risk definition: what is cash flow risk?
You need a steady flow of cash on hand to pay vendor invoices and daily operating costs. Cash flow risk describes any obstacle to this healthy cash flow. Typical risks could include things like unexpected expenses, decreases in revenue, or sudden market fluctuations. All these examples create the potential for negative cash flow and corresponding financial risk.
With cash flow risk management, you can identify and assess these risks while finding ways to deal with them. It’s important to plan for the unexpected in business to ensure you’re able to continue meeting all financial obligations. Here are a few terms used in cash flow risk management:
Cash Flow at Risk (CFaR): Risk of market variables causing a reduction in future cash flows
Value at Risk (VaR): Risk of future investment value falling
Liquidity Risk: Risk of a business being unable to meet short-term financial obligations
What are some cash flow risk examples?
In the case of market conditions, typical cash flow risk examples could include an economic downturn and its knock-on effects. During times of downturn, lenders raise interest rates and customers tighten their belts. If a small business doesn’t have assets to liquidate, this can lead to negative cash flow. Additional examples of cash flow risks include changes in commodity prices and fluctuating currency rates.
What are the elements of a cash flow risk analysis?
The first step in reducing your cash flow risk is to look carefully at your company’s finances. This starts with the cash flow statement, which gives an overview of cash inflows and outflows over time. When preparing these figures, you can use liquidity ratios like the cash conversion cycle and others to measure risk. Look at factors including historic sales patterns, market trends, and both short and long-term liabilities as part of your cash flow risk analysis.
Tips for managing cash flow risk
Now that we’ve identified some of the causes of cash flow risk, here’s how to reduce it.
1. Review your budget regularly.
Performing a regular cash flow risk analysis ensures you aren’t hit with any surprises. All businesses should review expenses to see if you’re making unnecessary purchases. Are there areas where you can cut back? Are you being overcharged by vendors?
2. Set up a contingency cash reserve.
There are some major expenses that can’t be planned for in your everyday budget. This is where a contingency plan is important. Set up a separate account with cash to be used only in case of emergencies. This gives your business a safety net to deal with cash flow issues.
3. Review customer credit terms.
Do you offer credit to customers? Establish limits to prevent debts from growing too high and stalling your cash flow. Ask customers to pre-pay for services or make a payment on deposit. You can also use payment terms with a shorter time frame, such as Net 15 rather than Net 45.
4. Automate your cash flow processes.
Consider using software to manage cash flow risks by performing regular assessments. You’ll have full visibility of all cash flows by setting up efficient automated workflows. It’s a good idea to centralise data for real-time financial reporting and account reconciliation. That way, if there are any issues with purchase orders and invoices, you’ll catch and correct them quickly.
5. Optimise the payments process.
One of the best ways to reduce cash flow risk is by making it as easy as possible for customers to pay you. Offer a range of payment options and follow up on all invoices. Consider giving incentives for early payment, such as a discount or free shipping.
Using GoCardless to collect payments can help your business improve cash flow. It puts businesses in control over incoming payments for on-time collection, reducing debtor days and awkward conversations. Pull recurring invoice payments directly from the customer’s bank account using Direct Debit or accept one-off payments with Instant Bank Pay. It’s fast, secure, and easy to start reducing your cash flow risk.
We can help
GoCardless is a global payments solution that helps you automate payment collection, cutting down on the amount of financial admin your team needs to deal with. Find out how GoCardless can help you with one-off or recurring payments.