Financial & Credit Risks

Guide to Cash Flow and Cash Flow Management

What Does Cash Flow Mean?

Cash flow describes the amount of money that a company earns or takes in every month. Simply put, it's recorded income, not IOUs. Cash flow is an important metric for financial performance, as a company needs to have sufficient cash "flowing" into the business every month so that it will be able pay its monthly expenses. After deducting monthly expenses, the money left over is the company's profits. 

How to Manage Cash Flow

The goal of cash flow management is to keep a business’s income higher than its expenses at any given time. In layman’s terms, this means that a business should be earning more than it spends. This might sound simple, but many companies experience difficulty in balancing accounts receivable with accounts payable.

When a business takes cash flow management seriously, it can meet payroll, rent, and other overhead costs. Companies that fail to manage cash flow may find themselves unable to access the funds needed to operate, resulting in growth stagnation or outright failure. These high stakes make cash flow management a major component of minimizing financial risk.

Cash flow management has always been a prerequisite for running a successful business. One component of cash flow management that many professionals find valuable is the effective use of business data and analytics to evaluate cash flow risks. Here are several ways companies use data to optimize their cash flow with precision.

Using Business Data to Protect Income

In a nutshell, a company needs a reliable revenue stream and influx of cash in order to stay cash-positive. For business-to-business firms, this usually hinges on invoices being paid on time. When due dates come and go without payment, a business may find itself short on cash to pay its own debts. Collecting on accounts receivable keeps companies solvent.

One way to understand the risk of non-payment for a specific company is to review all the data you can find on the business. Such information is valuable whether you’re evaluating a potential customer or simply keeping tabs on an existing client.

Elements such as trade references, financial statements, and firmographic data are some of the insights that may help business leaders segment and diagnose slow-paying businesses. Gaining increased transparency into the financial performance of another business helps decision makers better understand the risks associated with their customer. Similarly, business development teams can use such tools to decide whether to engage with a potential partner or not.

There are multiple indicators that can be used to assess risk, including:

Business Credit Scores & Ratings

Business credit bureaus are continually collecting information on companies all over the world. This data is used to calculate a variety of business credit scores and ratings that make it easier to understand the financial health of a company. For example, the D&B PAYDEX® is a dollar-weighted indicator of a business’s past payment performance, while the D&B® Delinquency Predictor Score predicts the likelihood that a company will pay late in the future. Such historical and predictive scores make it easier to understand the potential risks another business may present to your cash flow.

Lawsuits, Liens, and Legal Judgements

Liens can be placed upon inventory, real estate, or equipment to compel a company to make good on its debts. The best business information tools collect this data from trustworthy sources, such as government records. Previous or current legal events could suggest that a company may present an unacceptable level of risk. Dun & Bradstreet is the only credit data provider in the US that provides infomation on lawsuits, which can clue you into to a company's financial distress years before the resulting legal judgement.  

Trade References

Past payment behaviors by a company can help a business anticipate how its own invoices may be handled. These trade references are voluntarily provided to business credit bureaus by vendors, lenders, landlords, and other partners. This level of visibility into late payments or defaults can protect your business’s cash flow from unreliable partners.

Cash Flow Management & Spending Decisions

Accurately projecting a business’s income is one part of cash flow management and optimization; responsible spending is the other. The business information mentioned above is equally useful when evaluating suppliers and partners. If you rely upon a business partner for goods or services, their failure can threaten your company’s balance sheet.

Conducting research into the reliability of another company can remove poor candidates from consideration. This level of insight should make your cash flow projections more useful.

Cash Flow Forecasts & Projections

An important part of business management is budgeting and cash flow forecasts enable you to plan ahead. Forecasting can tell you how much revenue you'll be earning in the short-term and therefore, how much you can afford to spend to remain profitable. A cash flow forecast differs from a sales forecast in that the sales forecast anticipates new business (but is not guaranteed), but the cash flow forecast only lists guaranteed income.  

Cash flow forecasts and other types of financial projections can help anticipate different scenarios so you can take action before the company’s cash flow suffers. For instance, how would your business fare if it lost X% of your customers? Performing cash flow projections can help give you the leverage you need to be in a better position to react to such situations.

5 Tips to Help Protect Cash Flow

  1. Create a Credit Policy - If you extend credit to your customers or clients, then you need a credit policy that clearly defines your billing terms, acceptable payment forms, interest charges, and credit check process set in stone.
  2. Make it Easy for Your Customers to Pay - Billing errors and confusing invoices can lead to disputes and non-payment. Make sure your customer data is correct and make it easy for your customers to remit payments so you don't disrupt cash flow.
  3. Require Partial Payment Upfront for Larger Orders - If you are contracted to provide a large order or you take on a time-consuming project, consider requiring a partial payment upfront to help protect your business. The terms should also require full payment of the remainder upon the completion of the job.
  4. Pay Business Credit Card Balances Off Every Month - Business credit cards can provide purchasing convenience, but their interest rates can have you paying extra. To prevent accruing high interest charges, consider making it a habit to pay off your entire credit card balance by the due date every month.
  5. Negotiate With Vendors and Suppliers - Most businesses grant 30-day terms, but by negotiating with your vendors and suppliers, you may be able to get your terms extended to 60 or even 90 days. This can keep cash in your business longer and can allow you more flexibility when managing your other accounts payable. As long as you're paying within terms, your business credit scores and ratings won't be affected.

Data Quality is Key to Managing Cash Flow

When making decisions that impact cash flow, your plan is only as good as the data. It’s imperative that the business information being referenced is up-to-date and accurate. And managing risk requires stakeholders to be aware of new developments that could threaten cash flow.

Business data should be collected from reliable sources, such as government agencies, public financial documents, court records, and trusted research firms. A business’s financial situation can change rapidly. Several data providers offer continuous monitoring and automated alerts when financial indicators take a turn for the worse.

Understanding the fundamentals of how data is collected and delivered is important to effective cash flow management. Incorporating these insights can help businesses respond to the many risks that face every enterprise.

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