Cash Flow: How to Plan Liquidity and Avoid a Shortage of Funds

Liquidity shows whether a company can meet its payments when they fall due. It is not the same as profit. A business may report a good financial result and still lack sufficient cash for salaries, VAT or suppliers if receivables are collected slowly or too much capital is tied up in inventory.

What is cash flow?

Cash flow describes the actual movement of money into and out of the business. For management purposes, it is useful to distinguish between:

• operating cash flows — receipts from customers and payments relating to day-to-day operations;
• investing cash flows — purchases or disposals of long-term assets;
• financing cash flows — loans, owner contributions, repayments of financing and other capital movements.

Why is profit not enough?

If you sell a service for €20,000 with payment due in 60 days, the revenue may be recognised today while the cash is still unavailable. Salaries, rent and taxes, however, need to be paid on specific dates.

This timing difference is exactly why cash flow needs to be managed separately from accounting profit.

Prepare a short-term forecast

For many companies, an 8–13 week forecast updated every week is useful. It does not require complex software, but it should be built from real data:

1. opening bank and cash balances;
2. expected receipts by customer and date;
3. suppliers and due dates;
4. salaries and social security contributions;
5. VAT and other taxes;
6. loans and leases;
7. one-off investments;
8. the minimum desired cash reserve.

Which warning signs deserve attention?

• turnover is increasing while the bank balance consistently declines;
• receivables are growing faster than sales;
• suppliers are paid significantly earlier than customers pay you;
• a large proportion of cash is tied up in inventory;
• VAT and tax payments regularly surprise management;
• short-term borrowing is repeatedly used to finance normal operating costs.

How can cash flow be improved?

The answer depends on the cause. Possible measures include shorter customer payment terms, deposits, more active collection of receivables, negotiating supplier terms, optimising inventory, phasing investments or arranging appropriate working-capital financing.

Measures should not damage commercial relationships simply for a short-term improvement. The cash-flow forecast should therefore be connected with the wider business strategy.

A report should lead to action

A spreadsheet has no value if nobody uses it to make decisions. Define a minimum cash level, identify critical periods and assign responsibility for comparing the forecast with actual payments every week.

DESLIN’s Comprehensive Accounting Services can include financial analysis and support with organising useful management information.

This material is for general information only. The appropriate liquidity reserve and financial decisions depend on the operating cycle, risk profile and structure of the individual business.