The reasons may be wide and varied—late-paying customers, high upfront production costs, inventory purchases—but at the end of the day, cash flow gaps can be devastating. Companies struggle to pay their bills, meet payroll, invest back into the business, maintain good credit, and so on.
The best way to mitigate cash flow gaps is to be prepare, and there are many strategies for doing so. Yet when you’re wrapped up in the “busyness” of running a business, they may not come that easily.
Let’s break down the ABCs of cash flow planning that can help with overcoming cash flow gaps and improving your fiscal health.
The ABC’s of Overcoming Cash Flow Gaps
A is for Ask for Help
Overcoming cash flow gaps and managing overall cash flow is a delicate balance and comes down to many factors:
Having transparency into timing and movement of cash in and out of your business
Knowing your personal financial risk tolerance
Understanding your cash conversion cycle
Managing your margins—the higher your margins, the more risk you can take with accounts receivable
Managing cost of goods sold (COGS)
Minimizing the chances of late payment by knowing your customers, practicing good invoicing hygiene and collections, and finding ways to close the gap when a customer does pay late
Wrapping your head around all of this can be overwhelming, but an accountant can help. Their job is to help you improve your finances, and that starts with planning and advice on the right way to manage debt and cash flow in the context of your big picture finances.
B is for Breaking Even
A breakeven analysis is essential if you are to ensure the success of your company. Your breakeven point occurs when your business can cover all fixed and variable expenses (the latter fluctuates in relation to sales) and begins to make a profit.
However, profit alone isn’t sufficient, as you need to have a margin of safety that allows for your business to remain in the black even if sales take a slump.
Likewise, if you experience a surge in sales, you need to understand if you can afford to scale up based on the impact on production costs, inventory, A/R, A/P, machinery and equipment, labor, etc. It’s an exercise that can be more complex than it sounds, and, again, it’s a good idea to consult a CPA.
C is for Cash Flow Analysis
We’ve talked about cash flow planning, but a key part of that process (and directly related to your breakeven analysis) is cash flow analysis. This involves a review of the cash that flows into your business (net profits, financing, etc.) and out (bills, debt, increasing inventory, etc.). This data is recorded in your cash flow statement.
This information, more than any other financial analysis, gives you a keen picture of your business’ fiscal health and how you’re doing in terms of getting paid on time, making payroll, and how much cash you have left available each month after you’ve fulfilled these obligations.
It’s important not to confuse the cash flow statement with your cash flow forecast. While the statement looks back (like your bank statement), the cash flow forecast can help you predict your cash situation for the next month, quarter, or even year. You can use historical trends from your cash flow statement to inform your forecast as well as data from your sales projections, inventory plans, and so on.
The cash flow forecast is an incredibly useful tool for helping you predict any problems before they occur so you can put steps in place to mitigate them.
Most accounting software includes cash flow statement and forecast reports that you can create based on your existing accounting data, or you can use this cash flow forecast template from SCORE. You can also work with your accountant on this one, especially if it’s your first time creating these.