The aim of good cash flow planning is to have cash available to pay expenses. At the same time, you want to reduce the amount of capital (cash) you have to borrow to fund these expenses.
Like many businesses, you are probably a cheap form of finance for your customers. By allowing a customer to take your goods and pay you in 30-, 90- or 120-days, you are lending them money at 0% interest for that amount of time.
Every dollar you lend to a customer is money you have to either a) borrow at interest, or b) remove from your interest-earning cash reserves. The cash you lend to your customers through payment terms is a discount on your products or services.
How success can lead to cash flow trouble
The paradox of this situation is evident as your business becomes more successful and your cash flow starts pulling you in two different directions. You start lending more money to your customers through payment terms. At the same time, your expenses become larger and you need more available cash to pay these bills. The more money you lend to your customers, the bigger your own cash flow requirements become and the more risk you assume. The longer the lending period, the less money you have to pay your own bills, wages, and loan repayments. This is why lots of businesses end up in big financial trouble due to growth!
5 Ways to improve your cash flow
So how can you improve your cash flow?
- Collect your money as quickly as possible
- If you have given your customers 30 day payment terms, make sure they pay on or before this date.
- Reduce your terms to a shorter period as possible, e.g. seven or 14 days – as close to zero days as possible.
- Does it make sense to pay someone to focus on collecting your accounts receivable? Would this be cheaper than the cost of financing these outstanding debits to your business?
- Split the terms for goods and services
- If you purchase goods or services for a customer, ask for payment as soon as you purchase them.
- Only offer terms on services, the number of hours worked.
- Coordinate your accounts payable and accounts receivable terms. For example, if you have to pay for goods in 30-days, offer your customers 20-day terms so you have the cash before you have to pay it out. That way you aren’t financing the gap.
- Offer an incentive for your customers to pay early. If you have to pay 8% on the money you borrow on your overdraft, offer your clients a 2% discount to pay early or up front and you are 6% in ahead.
- Don’t offer credit!
- Do you need to offer credit to your customers to sell your goods and services?
- Would they still buy from you if you didn’t offer credit? If not, why?