Cash flow is the lifeblood of your business. Every successful entrepreneur and investor will offer the same advice: Know your numbers. This is because if you aren’t on top of every cent going into your business and coming out of it, you can’t be sure that your business model is operating the way it should be, or if you’re making a healthy profit.
Tracking your numbers is how you benchmark how your business is doing. Good financial management systems are the foundation of your ability (and that of your finance team) to keep a handle on your numbers.
It’s also how you will spot problems before they arise, giving you the opportunity to solve them before the business is in trouble.
There are three key elements to your financial management system: your cash flow projection statement, a good accounting system and your overall systems and processes to keep everyone on track.
1. Track your cash flow and projections
In its simplest form, cash flow is the money coming in and out of your business. It isn’t outstanding invoices or large deals that have been signed but not yet delivered on. It’s not what the business should or could make it in the next month. It’s the exact amount of cash that will be paid into your bank account, and the exact amount that you will pay in overheads, expenses, to suppliers and so on.
The key to healthy cash flow, however is that you need more cash coming in than you have leaving the business. And the way to achieve that is through your projected cash flow statement.
Creating your projected cash flow statement
- To create your projected cash flow statement, start with your first row detailing how much cash the business has on hand at the beginning of the month.
- Now list each of your operational expenses, detailing every expense you need to cover within the month.
- You then need to add all of your expenses up, and subtract your total cash required, from your total cash available. This will show you have you have enough cash to cover your expenses that month.
- You will also track the cash coming in over the course of the month (this will impact the next month’s cash at hand in your opening column.
- Ultimately, a cash flow projection allows you to do a number of things:
1. Track if your income is covering your expenses
Keep an eye on whether invoices are being paid on time – if you expected to have a certain amount of cash on hand at the beginning of the month, but didn’t, you can interrogate why. Often you will find that invoices are not being paid on time.
You can choose what to do with surplus cash, particularly if you can see you will have surplus cash for a number of months given your projections – will you invest the cash, purchase additional equipment and so on?
Finally, the ability to show cash deficits, surpluses and the timing of both helps enormously if you are trying to set up a line of credit with a bank or lender. It shows you understand your business, your numbers, and even if you are going to have a cash deficit, possibly because your business is seasonal, you’ve spotted it well in advance. These are all things finance houses look at when deciding whether or not to extend a line of credit.
2. Set up an accounting system
The only effective way to keep track of who you need to pay and who owes you money, is through an accounting system and solid financial records.
An accounting system is much more than just sending invoices and capturing payments though. It’s an essential element in tracking how your budget is performing versus what’s actually happening in your business.
There are two types of accounting methods that you can choose from: Cash and accrual.
- A cash-based system is generally chosen by businesses that trade predominantly in cash transactions. It tracks transactions according to when cash was paid or received.
- An accrual system records transactions or sales at the time that they occurred. This means sales orders and invoices are tracked, regardless of whether or not payment was received at the same time.
If you choose an accrual system, it’s essential that you don’t only track orders and invoices, but whether invoices have been paid.
Key mistakes business owners make when utilising the accrual system include:
- Not paying close attention to their debtor’s book, which means they capture sales and revenue on paper, but don’t make sure the cash is actually in the bank.
- Not paying close attention their debtors’ age. This refers to how long it takes a customer to pay you. If your average debtor’s age is 30 days, most of your customers are paying you on 30 days. But if your average debtors’ age is 45 or even 60 days, your customers are all paying you late – and you don’t have a proper system in place collecting your cash.
Build a strong accounting system
The key to healthy finances and a healthy cash flow is a strong accounting system that is both automated with a good accounting software package and is reviewed regularly by you and your finance team.
With this in place you can:
- Track your cash flow
- Ensure you’re getting paid
- Monitor payments and chase invoices.
3. Build Systems and Processes
There are two simple rules to set up robust systems and processes that support your business’s growth:
Do set up a system that makes sense, is simple to use and follow, and streamlines work without adding unnecessary complexity. Regularly review what everyone is doing and look for quicker, smarter and more cost-effective ways to do what you’re already doing. The more a system is refined, the better it will perform. You also want your team on board, using the system instead of fighting against – regularly asking for input and then making changes where good advice has been received gets everyone involved in the organisation’s overall efficiency.
Don’t include steps and processes simply because that’s the way things have always been done. There are multiple different cloud software solutions that are automating previously manual processes. Utilise them – they will free your managers and finance team up to focus on value-adding work, instead of manual, routine work.
To set up your systems and processes, ask the following questions:
- What tasks are done daily in the business that can be automated?
- How is customer information captured?
- How are sales orders captured, stored and tracked?
- Is there a process in place for receiving sales orders and sending invoices?
- Who is responsible for these steps?
- How are invoices tracked?
- How are invoices paid and who chases late payments?
Once you have all of these answers down, you can design a system that streamlines your business. Your ultimate goal is to be able to invoice customers as quickly as possible, with zero errors that could delay payment.
Mistakes to avoid
Unfortunately, financial management is an area that many businesses – particularly start-ups – make errors.
Not keeping a close eye on invoices. If you aren’t tracking who needs to pay you, your cash flow will suffer and you might even end up in debt.
Sending invoices late or full of errors. Incorrect client details could delay payment, particularly if the client sends the invoice back.
Not focusing on cash flow projections. The earlier you can spot problems on the horizon, the longer you have to trim costs, increase sales or approach lenders for a line of credit.