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Why is setting cash flow objectives important?

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Last editedOct 20222 min read

Effective cash flow is essential for all businesses, particularly SMEs. All businesses should make it as efficient as possible. Setting appropriate cash flow objectives plays a key role in making this happen.

Cash flow basics

Cash flow is the process of a business earning cash income and using it to pay cash expenses. Although the term ‘cash’ isn’t taken literally anymore, it does still refer specifically to money as opposed to other assets. It also refers to cash you actually have, not accounts receivable or payable.

The key to effective cash-flow management is to make sure that your income always covers your outgoings. Ideally, leave a little to spare. You don’t have to build significant cash reserves. The interest earned on these has to be set against the potential benefit of putting the money to work.

Understanding cash flow objectives

Cash flow should be captured on the cash flow statement. Even if your company is not required to file a statement, still create one. The main purpose is to record your cash income and outgoings over a given period. The second one is to facilitate your work towards your cash flow objectives.

Maintaining visibility of your global cash position

Keeping on top of your global cash position can be a challenge. SMEs are often encouraged to accept as many different payment options as possible. The logic behind this is that the more payment options you offer, the more likely you are to find yourself offering one the customer wants to use.

In reality, many customers naturally default to Direct Debits, followed by Instant Bank Payments, card payments and ewallets; in some environments, mobile payments may also be popular. So there is little to be gained by supporting more niche payment methods. There can, however, be a lot to be gained by streamlining your payments.

The easier it is to stay on top of your global cash position, the more likely it is that you will. It helps you to calculate your liquidity and solvency positions accurately, and use common ratios confidently.

Categorising your income and outgoings

Companies that have to produce cash flow statements categorise their cash activities into operating activities, investing activities and financial activities. Companies that don’t have to may use any categories, but it’s advisable to use the standard categories. That way your data is in a format third parties recognise.

Monitoring the timing of your income and outgoings

Healthy cash flow requires more than having your incomings match or exceed your outgoings. Make sure that you have received your income in time to pay your outgoings, allowing a margin of error in case of delayed payments. 

These are not necessarily caused by issues with the payer, but possibly by scheduled bank holidays or technical issues outside the payer’s control.

Forecasting, planning and budgeting

Understanding your cash position and its movement is essential for making accurate forecasts, plans and budgets.

Communicating with stakeholders

Public limited companies must produce cash flow statements because a company’s cash flow situation is important information for shareholders. Private limited companies and sole traders do not have to produce financial statements as they do not have shareholders. They may still need to convince people to give them financial backing, so cash flow statements can be vital for this.

Identifying areas in need of improvement

Having a clear picture of your incomings and outgoings highlights your operational strengths and weaknesses. For example, if you continually have issues with late payments, switch to Direct Debit. This puts you in control of payment collection and helps to minimise issues with late payments.

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