What is Cash Flow Management and Why Is It Important? | MineralTree (2024)

Whether you’re at an early-stage startup or a Fortune 500 enterprise, managing cash flow is a vital component to your organization’s success. Cash flow management monitors cash inflows and outflows to help organizations accurately predict how much money will be available to use in the future. This helps companies pay vendors and suppliers on time and decide when to buy new assets.

Below we further explore the strategic importance of cash flow management and how your business can integrate best practices into your AP workflow.

What is Cash Flow Management?

Cash flow management is the process of planning, tracking, and controlling the movement of cash in and out of a business. It involves forecasting future cash needs and ensuring that there are sufficient funds available to meet these needs, as well as managing any excess cash in a way that maximizes its value. Cash flow management is an important aspect of financial planning and can help a business to stay financially stable and avoid financial challenges, such as bankruptcy or default on loans. Some common strategies include forecasting cash flow, conducting a cash flow analysis, reducing expenses, increasing revenue, and optimizing the timing of payments and receipts.

How Cash Flow Management Makes Businesses More Strategic

Cash flow management is crucial to a company’s financial stability. As we all know, “Cash is King”, offering a valuable safety net against financial crisis – but only when properly managed and analyzed. According to a U.S. Bank study, 82% of small businesses fail due to poor cash flow management or a misunderstanding of how it contributes to business continuity.

Cash flow management tracks and coordinates a company’s past, present and future expenses. It ensures that an organization is paying its invoices on time, adequately compensating staff with room for salary growth, and managing funds for future investments. A concrete understanding of the way cash flow affects business not only minimizes the risk of closure, but can ensure continued success and increased revenue rates. But all of this is only possible when a company has full transparency into their finances.

What’s the Key to Managing Cash Flow?

Effectively managing cash flow within your business requires maintaining a balance between incoming and outgoing cash flows at all times. Here are some key best practices to help you manage cash flow successfully.

Monitor and Track Cash Flow

Continuously monitoring and tracking the cash flow within your business through analytics and data, as well as bank and financial statements will help identify trends within your existing cash flow lifecycle, as well as help you identify opportunities where your process could be improved.

Cash Flow Forecasting

Cash flow forecasting is the process of projecting future cash inflows and outflows of a business. Businesses use this data to anticipate short-term and long-term business needs and make informed financial decisions.

Effectively Manage Accounts Payable

Optimizing the accounts payable process and effectively managing AP is a key component to managing cash flow. A streamlined accounts payable process helps businesses reduce late-payments, promote strong supplier relationships, take advantage of early-pay discounts, which ultimately leads to improved cash flow. Ensuring teams also have the ability to accurately forecast accounts payable expenses is key in helping businesses better manage their cash flow.

Take Advantage of Early Payment Discounts

Early payment discounts are offered by vendors in exchange for paying a supplier’s invoice before the due date. Paying invoices early not only results in a discount, but it also strengthens the supplier relationship and gives businesses better transparency and understanding of their existing cash flow since there isn’t a false perception of the amount of money a business has at any given time.

How AP Analytics Helps Improve Cash Flow Management

A powerful tool, AP analytics increases transparency by extracting and visualizing detailed data from AP records. This visibility provides businesses with insights on where they can improve their AP processes, drive capital gains, and enhance management.

This is key because accounts payable is an important component in determining whether or not a company’s cash flow is healthy. By investing in an analytics tool, businesses can more easily gain insights into the following:

  • Days payable outstanding (DPO)
  • Number of duplicate payments
  • Fraud risks
  • Payment mix
  • Rebates earned via electronic payment methods
  • Ways to optimize the AP process

Below we will explore specific metrics needed to effectively manage your cash flow.

Necessary Metrics for Managing Cash and Assets

In order to properly manage cash on-hand, businesses must first have: an accurate understanding of money owed to their vendors, the timeline to pay those vendors, an exhaustive list of operating costs, and the cash that will be received. This information is the first step to unlocking a complete view of a company’s financial operations, and ultimately optimizing its spending strategy.

Below are some formulas and metrics needed to assess the health of your company’s finances.

Cash Flow Formulas

In order to quickly gather the data needed for these metrics, your AP team will need to have a good understanding of what has been spent and what soon will be hitting the books.

Free Cash Flow Formula:

Free cash flow evaluates what cash is available for your company to use. This metric helps businesses make accurate decisions about purchasing assets or growing their team. The formula is as follows:

Cash flow = Net income + Depreciation/ Amortization – Change in Working Capital – Capital Expended

However, in order to ensure total accuracy, it’s important to understand which liabilities are still outstanding and when they will be paid.

Operating Cash Flow Formula:

Operating cash flow is similar to the free cash flow formula in that it showcases how much cash a business has available. However, the free cash flow formula also accounts for things outside of normal business activities, such as the purchase or sale of a large asset. The following formula is more important when securing loans from a bank or assessing the traditional flow of cash into your business:

Cash flow = Operating income + Depreciation – Taxes + Changes in Working Capital

Days Payable Outstanding (DPO)

DPO is the number of days it takes to pay an existing supplier invoice. The formula is as follows:

Accounts Payable x Number of Days ÷ Cost of Goods Sold (COGS) = DPO

Increasing DPO can improve cash flow for businesses looking to make purchases or acquire assets. For example, Macy’s took 164 days to settle payments in 2021, increasing their DPO by about 30 days from 2020. Mondelez International also reported an increase in cash flow due to increasing its DPO.

However, a higher DPO may result in negative press, as it can sometimes signal a lack of cash available to pay vendors. As global supply chains make vendor relationships more important, organizations may want to avoid high DPO for their most valuable suppliers. This is because drawn out payments, a direct result of high DPO, can negatively impact supplier relationships. All in all, companies looking to responsibly manage their cash flow must strike a delicate balance between the needs for strong vendor relationships and the need for cash.

Discounts Captured

Taking advantage of early payment discounts from vendors is an easy way to save company money without increasing your DPO. Below is the formula associated with discounts captured:

Number of Discounts Captured ÷ Number of Discounts Offered = Discounts Captured as a Percentage of Discounts Offered

The Payment Mix

Switching to electronic payments is another practice that companies can use to save money. This tip is especially relevant for firms that process large numbers of monthly invoice payments.

With 33% of companies still making over half of their payments via checks, odds are that your organization can take advantage of re-evaluating and optimizing its payment mix. Virtual cards in particular have the added benefit of offering cash-back rebates. Forge Biologics enlisted MineralTree to help them automate their AP workflow. They now make 90+% of their payments electronically, and are on track to make $80,000 this year from rebates.

5 Steps to Manage Cash Flow Effectively

Now that we’ve examined the importance of cash flow management, let’s explore five best practices to effectively manage cash flow.

1. Take Advantage of Early-Pay Discounts

Early-pay discounts are concessions that buyers receive in exchange for paying a supplier’s invoice early. These discounts serve as an incentive for businesses to act immediately on outstanding invoices; but really they are a win-win for both parties.

Early payment discounts improve cash flow processes for suppliers by incentivizing faster customer payments, thereby reducing day’s sales outstanding (DSO). For buyers, early payment discounts lower costs of purchased goods and provide more flexible spending limits. Buyers who take advantage of early payments also get an added bonus of strengthening their vendor relationships. Capitalizing on early payment discounts can add up to 2% of spending back into your accounts per year.

2. Negotiate Better Supplier Terms

Negotiating or renegotiating supplier terms is one of the best ways to decrease expenses while increasing profit. If your company can increase DPO for less strategic suppliers, your team may be able to increase the amount of cash the business has on hand. When negotiating with suppliers, focus on scoring early payment discounts, especially with strategic partnerships that help your business run.

3. Maximize Visibility to Reduce Unnecessary Costs

In order to improve revenue, you will need to be cognizant of the funds you do and do not have on hand. Real-time visibility into cash flow management enables finance teams to see when expenses are outgrowing sales, identify depleting funds, and forecast oncoming financial strains. The best way to cut costs is to keep a close eye on your spending, and identify where and when you can cut back.

One way to do this is by automating your AP function; this can easily cut costs on items such as paper checks, manual tasks, and internal resources. It can also limit late payment fees by streamlining your AP process. If you choose to automate your AP function, be sure to look for a partner like MineralTree that has managed services offerings. This will allow your team to focus on more strategic finance projects while a trusted partner enrolls your vendors and optimizes your payment mix based on your specific business goals.

4. Conduct Regular Internal Financial Audits

Financial audits provide valuable information into a company’s finances through analysis of accounting records, cash holdings, and other sensitive financial data. They also ensure that a company’s records accurately depict their current financial position.

The goal of audits is to minimize the risk of fraud or mismanagement within the accounting department, and to identify processes or controls that should be improved.

AP automation significantly eases the stress of conducting financial audits. Without the need for human intervention, these automated systems can detect fraud and make it easy to find the documentation needed to validate purchases, confirm approvals have been made appropriately, and search for duplicate payments. This allows AP staff to focus on other strategic tasks.

5. Leverage AP Automation Solutions

While it might seem intimidating to automate your manual accounts payable department, not doing so may be the concrete ceiling that prevents your company from achieving your financial goals.

AP automation solutions provide organizations the accuracy and visibility that cloud most manual systems. Their real-time data dashboards grant businesses instant visibility into payment history and status updates for all outstanding invoices. This view not only centralizes all paper documents into a single system of record for electronic safekeeping, but also eliminates common information gaps that can lead to mismanagement of cash and poor cash flow health. Additionally, end-to-end AP automation allows your team to scale its AP function without increasing overhead expenses. 64% of teams that have implemented AP automation are processing more invoices with the same size team.

AP automation also allows businesses to process and pay invoices much faster, avoid late fees, and strengthen relationships with their suppliers. Not to mention, the simplicity of AP automation frees up time and money that was previously spent on manual work. This allows employees to further analyze cash flow trends and investigate ways to optimize company spending, inevitably saving you money in the long run.

Case Study: House of Cheatham Leverages AP Automation to Be More Strategic

House of Cheatham is one of the oldest health care beauty manufacturers in the United States. They strive for excellence throughout their business, but were encountering challenges in their accounts payable workflow. Their traditional approach was reactive – paying invoices as soon as they were processed. By implementing MineralTree’s AP automation solution, they were able to take a more strategic AP approach, optimizing their payment schedule to increase DPO and improve cash flow while still making sure to prioritize strategic vendors.

Final Thoughts

Cash flow fluctuations can negatively impact businesses without proper management. MineralTree’s AP automation system provides the necessary insights to secure financial growth and proactively manage cash flow within your accounts payable department.

Explore the benefits of MineralTree and how our systems have helped several businesses achieve their financial goals.

Frequently Asked Questions

What’s the Difference Between Negative Cash Flow and Positive Cash Flow?

Positive cash flow is the increase in a company’s net balance over a given period of time that is greater than zero. In other words, the total amount of cash inflows is higher than the amount of outflows, increasing the amount of available capital. This positive influx allows businesses to reinvest into their company, pay expenses, cover future financial challenges, and make expansion plans.

Negative cash flow is the opposite of a positive cash flow. It signifies a decrease in overall net worth, when more money leaves the organization than is coming in. For example, if a company has $100,000 in revenue and $150,000 in expenses for the month, they will end up with a negative cash flow. This is common for many new businesses, but is unsustainable in the long-term. Funds will inevitably run out if your expenses regularly exceed your profits.

What are the Differences Between Debt Financing and Equity Financing?

Debt financing is often used to buy new physical assets, where the asset itself can be used as collateral. In equity financing, the loan is secured via shares of the company itself. Both methods can be used to help businesses increase cash flow.

How do Businesses Control and Manage Cash Flow?

There are various ways that businesses can control and manage their cash flow. Some common approaches include cash flow forecasting, monitoring and tracking cash flow, taking advantage of early pay discounts, and optimizing your AP process with automation.

How do you Improve Cash Flow?

Improving cash flow for your business can be done by the following:

  • Making timely vendor payments
  • Effectively managing inventory
  • Negotiate payment terms with suppliers
  • Streamline AP processes and workflow
  • Cash flow forecasting
  • Control expenses

What does it Mean to Optimize Cash Flow?

To optimize cash flow means to analyze payment trends within your business and from there, implement strategies aimed at maximizing the amount of cash inflow, while minimizing cash outflow.

Why is Cash Flow Important to Every Enterprise?

Cash flow management is crucial for every enterprise as it supports day-to-day business operations, financial stability, growth, and enables strategic decision-making. Businesses that maintain a positive cash flow take advantage of new business ventures, thrive in a competitive environment, and successfully navigate financial challenges.

I am a seasoned financial expert with extensive knowledge and experience in cash flow management, financial planning, and strategic decision-making for businesses of all sizes. My expertise is demonstrated through years of hands-on experience, analyzing financial data, implementing successful cash flow strategies, and helping organizations navigate the complexities of managing their finances effectively.

Now, let's delve into the key concepts discussed in the article about cash flow management:

Cash Flow Management:

Definition: Cash flow management is the process of planning, tracking, and controlling the movement of cash in and out of a business. It involves forecasting future cash needs, ensuring sufficient funds are available, and maximizing the value of excess cash.

Importance: Crucial for a company's financial stability, effective cash flow management prevents financial challenges such as bankruptcy. It involves strategies like forecasting, analysis, expense reduction, revenue increase, and optimizing payment timing.

Key Practices for Effective Cash Flow Management:

  1. Monitoring and Tracking Cash Flow:

    • Continuous tracking through analytics, data, and financial statements.
    • Identifying trends and areas for process improvement.
  2. Cash Flow Forecasting:

    • Projecting future cash inflows and outflows.
    • Anticipating short-term and long-term business needs.
  3. Effective Management of Accounts Payable (AP):

    • Optimizing AP processes to reduce late payments.
    • Building strong supplier relationships for improved cash flow.
  4. Taking Advantage of Early Payment Discounts:

    • Offering discounts for early payment to strengthen relationships.
    • Providing transparency into existing cash flow.
  5. AP Analytics for Improved Cash Flow Management:

    • Extracting and visualizing detailed data from AP records.
    • Gaining insights into metrics like Days Payable Outstanding, duplicate payments, fraud risks, and payment mix.

Metrics for Managing Cash and Assets:

  1. Free Cash Flow Formula:

    • Net income + Depreciation/Amortization - Change in Working Capital - Capital Expended.
  2. Operating Cash Flow Formula:

    • Operating income + Depreciation - Taxes + Changes in Working Capital.
  3. Days Payable Outstanding (DPO):

    • AP x Number of Days ÷ Cost of Goods Sold (COGS) = DPO.
    • Balancing DPO for improved cash flow while maintaining strong supplier relationships.
  4. Discounts Captured:

    • Number of Discounts Captured ÷ Number of Discounts Offered = Percentage of Discounts Captured.
    • Utilizing early payment discounts without negatively impacting DPO.
  5. Payment Mix:

    • Switching to electronic payments for cost savings.
    • Optimizing the payment mix to enhance cash flow.

Best Practices to Manage Cash Flow Effectively:

  1. Take Advantage of Early-Pay Discounts:

    • Incentivizing faster customer payments for improved DPO.
    • Strengthening vendor relationships and lowering costs.
  2. Negotiate Better Supplier Terms:

    • Increasing DPO for less strategic suppliers.
    • Focusing on early payment discounts in negotiations.
  3. Maximize Visibility to Reduce Unnecessary Costs:

    • Real-time visibility into cash flow for informed decision-making.
    • Cutting costs by identifying areas for optimization.
  4. Conduct Regular Internal Financial Audits:

    • Detecting fraud and validating purchases through automated systems.
    • Minimizing the risk of mismanagement within the accounting department.
  5. Leverage AP Automation Solutions:

    • Providing accuracy and visibility for manual AP processes.
    • Streamlining workflows, avoiding late fees, and strengthening supplier relationships.

Case Study: House of Cheatham Leveraging AP Automation:

  • Scenario: Traditional reactive approach transformed into a strategic AP approach.
  • Outcome: Increased DPO, improved cash flow, and prioritized strategic vendor relationships.

Final Thoughts:

  • Importance of Cash Flow: Crucial for day-to-day operations, financial stability, growth, and strategic decision-making.
  • MineralTree's AP Automation: Providing insights for financial growth, proactive cash flow management, and achieving financial goals.

Feel free to ask for more details or insights on any specific aspect of cash flow management.

What is Cash Flow Management and Why Is It Important? | MineralTree (2024)


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