Business liquidity: How to optimize cash flow?

04 July 2022 by National Bank
An entrepreneur doing business accounting to manage cash flow.

Careful monitoring of your business liquidity or cash flow is key to sound financial management. It makes it easier for you to overcome obstacles such as inflation, supply chain issues and labour shortages. Here are some tips to help you calculate and optimize your cash flow.

Cash flow: pay attention to your business accounting 

The purpose of business accounting is to track cash inflows and outflows so you can analyze your company’s financial performance.

There’s a direct link between your cash flow and your business accounting. Having up-to-date data will make your business accounting more effective. That’s why it’s essential to check your cash flow on a weekly or monthly basis to know where you’re at.

When times are tough, you need to pay even closer attention to your management and business accounting.

Analyze your business liquidity 

Monitor your cash flow  

You need to keep a close eye on your cash flow to ensure you’re making the best use of your company’s liquid assets. “Cash flow” refers to how much cash your company takes in minus how much it pays out. It is influenced by the company’s cash-in model and how it pays its day-to-day expenses, such as salaries, purchases, rent and other fixed costs.

By estimating your future cash flows, you will have a good idea of how much cash you will have left, or need, at the end of the month. 

Calculate your working capital

You also need to track your working capital, which consists of your company’s short-term assets minus its short-term liabilities for the following year. 

  • Your short-term assets include assets that you’ll have in the next year (cash, accounts receivable, inventory). 
  • Short-term liabilities are all your accounts payable for the next year, including the short-term portion of long-term debt (such as principal and interest payments as well as your line of credit (if you have one).

Once you’ve tallied it all up, put your results in perspective by answering the following questions: 

  • Will all your receivables be cashed per the agreed upon terms? 
  • Will your company be able to convert inventory into cash sales or receivables? 

Good to know: The cash flow equation assumes that all short-term assets will be converted to cash in a timely manner. This is not always the case, however. You should keep in mind that some variables may change the way your short-term assets are calculated. 

Determine your business cash flow needs under different scenarios

If business slows, a decrease in cash receipts due to longer collection times could put pressure on your cash flow, since you’ll need to keep making your monthly payments regardless.

To make sure you’re ready for whatever comes, calculate three different cash projections based on three different scenarios (optimistic, realistic and pessimistic) for a set period of time. This will give you a clearer picture of your company’s financial situation, no matter what happens. 

Profitability is important, but liquidity is paramount

Your financial statements may show a financial situation that at first glance seems healthy, but with a high number of accounts receivable and a large inventory that actually mask a cash shortage. Without adequate cash or financing, your company may not be able to meet its obligations related to purchases, salaries, rent or other fixed costs. If that’s the case, you’ll need to increase your cash flow as quickly as possible. 

Take concrete action to increase your business liquidity

A number of measures can help you increase your cash flow. Here are a few:

  • Collect as much in the way of accounts receivable as possible. You must make every effort to recover these amounts as quickly as possible. But keep in mind that your customers may also be going through a rough patch. Consider offering discounts or payment options in some cases if you think it can speed up the collection process.
  • Use the latest transaction solutions to shorten your cash cycle (time to convert a sale into cash) with Interac® e-transfers and payment terminals or online payment processing solutions. They’ll allow you to convert your sales into cash faster. 
  • Manage your inventory levels closely. It’s important to keep them at an optimal level. For example, excess inventory could reduce your cash flow and increase your storage costs. In some cases, you might even want to reduce inventory levels by putting them on sale. However, when certain products are in short supply, you may lose sales opportunities if your stocks are too low. 
  • Sign payment agreements with your main suppliers. This is a good way to increase your short-term cash supplies. Some suppliers might be willing to accommodate you. 
  • Consider invoice factoring and whether it could be the solution to your company’s cash crunch. 
  • As a last resort, use your line of credit, if you have one. This can be a temporary solution to deal with delays in collecting your receivables or in obtaining funds from the various assistance programs for which you are eligible. But remember, this is a type of loan and there will be interest.

Learn from tough times 

Hard times don’t last forever. A challenging situation can be a great reason to do a full review of your company’s internal processes. Focus on improving and automating your processes. For accounting, consider using a cloud-based accounting platform.

Whatever the case may be, get expert advice before making a decision. Feel free to contact your accountant, account manager or a National Bank advisor to discuss your situation. 

Have questions? We’ve got answers. 

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