Before discussing the ways to improve cash flow, let us understand the concept itself.
Cash Flow is nothing but the total amount of money being transferred in & out of your business.
Take an example: On a particular day, if your business received a total of $500 & paid a total of $400 then we can say that your business’s cash flow for that day was $900 ($500 Cash Inflow + $400 Cash Outflow).
Cash Inflow means the money flowing into your business due to various revenue generating activities like sale of goods or assets.
Whereas, Cash Outflow is the money flowing out of your business due to various expenses like rent, salary, raw materials etc.
If the Cash inflow is higher than Cash outflow then we call it a positive cash flow. On the other hand, if Cash outflow is higher than Cash inflow then we term it as a negative cash flow.
From a business point of view, maintaining a healthy or positive cash flow is very vital. Why? Because negative cash flow may result in:
- Non-ability to pay operational expenses like salary or rent
- Stoppage of production (due to non-payment to suppliers)
- Loss of brand image, goodwill or reputation
- Litigation or legal issues
Do most businesses struggle with improving cash flow? Yes, they do. As per a study of SCORE, a whopping 82% of businesses fail due to cash flow problems.
Improving cash flow can significantly improve your top line figure multiple times. Dell, the computer electronics giant, was able to come back strong by simply improving its cash conversion cycle.
Now, it’s time to discuss some practical ways to improve cash flow.
HOW TO IMPROVE CASH FLOW
1. Reduce The Delivery & Invoicing Turnaround Time
Once you receive a purchase order, try to expedite the turn around time for delivery & invoicing. The faster the delivery & invoicing, the faster you will receive the sale amount.
This strategy is equally important in case you are into a service business. If so then try to initiate the service process within a deadline of 12 or 24 hours.
For fast delivery of goods or service (and invoicing), you would need a strong staff base. For invoicing, an automated system would be added advantage.
Global e-commerce leader Amazon nails this strategy like a king. Not only faster delivery ensures delightful customer experience but also improves their cash flow.
2. Improve Inventory Cycle
Inventory or stock cycle is the amount of time an inventory takes to convert into a sale. Generally, it’s calculated taking a number of days as a base.
Example: If a stock was bought on 1st April 2018 & was finally sold on 10th April 2018 then we can say the inventory cycle is roughly 10 days.
The logic behind this strategy is that the longer money is blocked in inventory, the more its going to hurt the cash flow. The faster the inventory sells, the faster will be the cash rotation.
To take this strategy to a new level, you may try out the Just-In-Time(JIT) inventory strategy. In JIT, inventory is purchased only when it’s actually needed.
Automobile leader Toyota was one that conceived & implemented the JIT inventory strategy. Therefore, JIT is also fondly known as the Toyota production system (TPS).
3. Have Buffer Cash Reserves
Bill Gates once said “When you have money in hand, only you forget who are you. But when you do not have money in your hand, the world forget who you are. It’s life”
The aforesaid quote holds true for a business as well. This is more of a common-sense strategy.
You should have some cash reserves (always) to tackle business downturns like economic depression, sudden fall in sales or natural calamity etc.
How much cash reserve should you have? As a thumb rule, I prefer keeping cash reserve equal to 10 months of average monthly operational expenses.
Example: If your business’s monthly operational expense equals $1000 then you should for a buffer cash reserve of $10,000 always.
4. Tweak The Sales Model
Instead of collecting sale amount after delivery, can you make the customer pay in advance? How? Simply offer them an attractive discount for pre-payment.
The earlier the payment, the healthier will be the cash flow.
This is a strategy which is being successfully implemented by many reputed e-commerce stores.
Example: If you are selling a product or service at $100 then offer a discount of $20 for pre-paid customers.
Remember, for this strategy to work well, your discount offer should be attractive enough.
5. Tweak The Payment Model
For sale, give an option or request your customers to pay electronically via credit cards. Avoid instruments like Checks that take more time to process.
For purchase, use a business credit card since it will ensure that you do not have an immediate cash outflow.
Note, you should carefully take into account the charges or interest to be incurred when accepting or paying via electronic means. Why? Because you don’t wanna jeopardize your profit in the race to get a favorable cash flow.
6. Negotiate For More Favourable Credit Terms
Ask for a longer credit term from your prime creditors or suppliers.
Negotiate for a shorter credit term with your prime debtors or customers.
Negotiation skills become crucial in this strategy.
To your suppliers, you need to give strong compelling reasons why raising the credit limit would benefit them. Example: Tell them that allowing longer credit period would make you grow fast & hence in long-term the suppliers would win with more orders (from you).
To your customers, you need to lure them to shorter credit period with incentives like cash discount etc.
7. Follow Up Receivables
A simple follow up with your customer can help in a faster settlement of dues.
For this purpose, you can use multiple communication channels like phone, email or post.
Remember that you need to follow up regularly & frequently.
For smooth execution of this strategy, I recommend using a spreadsheet for tracking the due dates, payment date, 1st follow up date, 2nd follow up date & so on. Also, the follow-up personnel needs to be in direct contact with the finance personnel for prompt updating of this sheet.
8. Consider Leasing of Assets
Leasing means taking possession of an asset in return for periodic installments. This ensures that there is no immediate cash outflow burden.
You can try the same for your business. It’s not difficult to lease the following:
- Office premises
- Plant & machinery
- IT Equipment
As discussed earlier, you will need to factor the cost difference (outright purchase is generally cheaper in long-term) before committing to improve cash flow via this strategy.
9. Incur Only Revenue Generating Expenses
Most businesses or startups get carried away with unnecessary expenses like:
- Fancy office expenses
How do you know if an expense is really worth it? Simple. If such expense helps your business to generate revenue which it otherwise won’t.
10. Consult An Expert
Last but not the least, you need to consult a CPA or CFA.
Such professionals can help you to understand your cash flow problems in more detail, prepare cash flow statement, implement solutions etc.
Of course, they do come with a professional fee.
So, we have covered all 10 practical ways to improve cash flow. All are equally important & powerful. But, you may decide to use or not to use any one of them depending on your particular case.
In business, the cash is the ultimate king. No matter what business problems you face, adequate cash gives you time & resources to fix those problems. Without cash, you are down & out.
Cash is also the strongest growth enabler. The more cash you have, the more chance for your business to grow fast.
What are your cash flow strategies? How about the aforesaid ways to improve cash flow? Comment below.