Published April 16, 2007

Cash Flow Balance: Cash Balance Management for Business

Irrespective of how good the product, how established the brand name, how valuable the plant and machinery and how dedicated and competent the staff, a negative cash flow could cause your business to crash.

Cash flow is an accounting term that refers to the amount of cash being received and spent by a business or a specific project, during a defined period of time. Measurement of cash flow is extremely important.

In a nutshell, cash flow can be used to:

  • Evaluate the performance of a business or project.
  • Calculate the liquidity of your business. A business that is profitable in the long term may face liquidity problems in the short term - and this could cause a profitable business to fail.
  • Project the rate of return - this is the basis for business planning.

Cash flow has two simple components - in-flow from sale of products or services and outflow as payments to suppliers. Cash flow is often used as an indication of a company's financial strength.

As simple as this may sound, in practice it is not so straightforward - largely because the element of credit enters into most businesses. Goods and services are sold on credit and materials are procured from suppliers on a credit basis. Therefore, credit management is a crucial aspect of cash flow management.

In order to run a business, goods and services have to be available for sale. To ensure this, man, material and money is needed to get the goods and services from the seller to the buyer. Cash flow is needed to pay labor and meet marketing and distribution expenses. Once the goods and services have been delivered, the payment has to be collected. Often, sales are made on a credit basis in order to close the sale. The time lag between the cash being received from debtors and the payment to be made for production against future sales has to be met by the cash flow. This is a delicate balance that has to be maintained.

An excessive cash balance against proposed operating expenses is expensive in the form of interest payable. Delayed payments from buyers or bad debts upsets the cash balance and increase costs. The often-overlooked costs of late payment can destroy the future of your business.

A negative cash flow does not allow a business owner to pay their creditors on time and therefore results in adverse credit terms, resulting in reduced or withdrawn credit limits or even delayed deliveries of materials. Therefore, in order to bridge the gap between delayed receivables and overdue payables, the business owner has to resort to short-term loans, thereby raising the cost of doing business.

Cash flow management, though deceptively simple on its face, requires a specialist (read: accountant) to manage the delicate balance between projected inflows and outflows. At no time should your business incur excessive expenses in the form of interest on a large cash balance. Neither should there be a negative cash balance that could cause even a temporary break in production.