Cash management is a crucial daily task of every small business. Its purpose is to ensure liquidity, keep track of cash flow, and manage short term investments.
Read on for our secret tips on effective cash management, and how Veem can help.
Liquidity means you’re able to fulfill your short term financial obligations or, in accounting terms, your liabilities which includes accounts payable.
Success doesn’t guarantee liquidity. Even if your business is thriving, you may experience serious trouble if your customers pay you after your own bills are due.
Success doesn’t guarantee liquidity. Even if your business is thriving, you may experience serious trouble if your customers pay you after your own bills are due. You need to prepare for these situations and have the necessary cash ready to remain solvent. But how?
1. Measure Your Liquidity
There are various ways to keep track of your liquidity. The most convenient method is financial ratio analysis.
Your current ratio measures your assets against your liabilities. Assets include cash, inventory, and accounts receivable, while liabilities are accounts payable, loans, wages, etc. The equation is simple: your assets need to surpass your liabilities.
However, a positive current ratio doesn’t guarantee solvency, since you can’t pay bills with inventory or accounts receivable.
Your quick ratio lets you know if you’re able to fulfill your short term obligations. Here’s a formula to calculate your quick ratio:
QR = (Current Assets – Inventory – Advances – Prepayments)/Current Liabilities
If your quick ratio is negative, you need to find a way to make quick cash.
2. Make Quick Cash
There are several ways to push your quick ratio to the positive side. The most obvious answer is to sell some of your inventory.
However, this also means more work for you, since you need to find a buyer, and make sure they pay you very quickly. Not impossible, but time-consuming nevertheless.
Another, less popular but very effective solution is to factor parts of your accounts receivable. Factoring means that you sell your invoices to a third party for around 90-95% of their value. You get your money upfront (albeit a bit less), and chasing the payment is not your problem anymore.
Be cautious, though. Factoring isn’t a favorable solution. Never use it with your regular business partners, as it will most likely sever the ties between you.
And finally, don’t pay your invoices before the deadline. Keep the cash in your business for as long as you can, while you wait for your own invoices to be paid.
3. Create a Cash Budget
A monthly cash budget will let you know how cash flows in and out of your business. In addition, it will show you the difference in timing between realizing profits and turning them into cash (it can be several months if not more).
Predict your cash needs and prepare cash budget projections for up to a year. These will be an immense help with cash management. If your needs change, modify your projections.
You can even play with them a little and create “best” and “worst case” scenario cash budgets, preparing you for all events.
While you’re experimenting, try new and innovative ways to reduce the wait in turning your accounts receivable into actual cash. For example, offer your business partners the most convenient ways to pay you. Like Veem.
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