Expert Opinion: Cash flow management for SMEs

The team from accountancy firm, Xeinadin, share their insights into the importance of cash flow management for SMEs, and strategies for managing it.

Every business costs money to run. But how you cover your day-to-day operational costs can depend significantly on how big your business is. 

While large corporations often have access to multiple lines of credit and assets they can liquidise quickly to raise working capital, SMEs tend to be much more reliant on the revenue coming into the business to cover expenditure directly. This is what we mean by cash flow – the movement of money in and out of the business. 

It’s common for inflows and outflows of money not to be exactly in sync in any business. You might, for example, be used to waiting 30 days for invoices to be paid. But if a big quarterly tax or energy bill falls due right at the start of your own billing cycle, you might be left relying on money in the bank – or credit – to cover those liabilities. 

If you have neither, you find yourself defaulting. It doesn’t take much – an unforeseen expense, money you are owed not arriving on time, or the cost of debts racking up as you seek short term loans to pay your bills – for a single missed payment to trigger the slide towards insolvency. 

An estimated 50,000 SMEs go out of business every year in the UK citing cash flow problems as the cause of their downfall. Many of these are otherwise viable businesses that have no way to cover costs when revenue doesn’t arrive in time to pay bills. Once you’re on that slippery slope, it can be very hard to scramble back to safety and solvency. 

That’s why sound cash flow management is so imperative for small businesses.

Understanding Cash Flow Management 

If cash flow can be defined in its simplest terms as the movement of money in and out of your business, then cash flow management is just as simply the tracking and control of cash flow. 

But as you might expect, in practice cash flow management is a little more complex than that. For a start, there are three different types of cash flow to consider: 

• Operating cash flow: This is what most people mean when they talk about cash flow – inflows of cash relating to the sales of goods and services, versus outflows relating to day-to-day operating costs (e.g. wages, money owed to suppliers, rent, utilities etc).  
• Financing cash flow: This describes any money coming into the business in the form of loans, investments and other types of credit/finance, and also what that might cost the business in terms of debt repayments etc. As mentioned, this is usually more relevant to larger businesses who generally have more financing options available to them. Although smaller businesses can often find cash flow problems spiralling when they turn to high-cost short-term loans to cover shortages in working capital. 
• Investing cash flow: Whereas operating and financing cash flow can be measured in short cycles (e.g month to month), investing cash flow takes a much longer-term view. This looks at the kind of outflows you might describe as investing in growth for your business – so purchasing assets, talent acquisition/development, product R&D, marketing spend etc – and then the returns you are getting. Investing cash flow has less of an immediate impact on the financial health of your business. But the ability to invest in growth at all is often contingent on strong and positive operating and financing cash flows. And poor investments that result in negative returns can drag down financial performance in the future. 

The goal of cash flow management is ultimately to make sure you have enough ready cash (liquidity) in the business to cover all liabilities as and when required. Cash flow management is therefore crucial to remaining solvent (the legal definition of insolvency being an inability to pay your debts).  

Effective cash flow management therefore depends on several things. It involves making sure that your business is earning enough money to cover all of its costs. But it also requires managing the timing of incomings so you always have cash available to make payments as required. Conversely, it involves keeping expenditure under control, and making sure you are not taking on more liabilities than you can cover in any given period of time. 

Continue reading on the Xeinadin website for five strategies for managing cash flow.