Cash flow management is sometimes called working capital management or liquidity management. Whatever you call this crucial activity, it consists in maintaining the ability to pay the liabilities and in the development of the company. The largest companies in the world with very effective liquidity management are able to plan cash flow with a 3-month outlook and an accuracy of about 95 %. Even if you manage to plan with less accuracy, reliable cash flow planning will become a source of your competitive advantage. 

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Basic equation of liquidity management 

Finances and their management are the basis for maintaining the long-term prosperity of the company. The basic task is to arrange and ensure the permanent solvency of the company. The requirements, which are the basis for the obligation to pay, are based not only on the received invoices and labour costs, but also on the liabilities to the state (taxes) and banks (repayment of credits) or on the expected investments. 

The basic equation of liquidity management is: 

🔢 expenses = income + balances of funds 

Therefore, if you maintain high current account balances, you will ensure good liquidity according to the above equation. However, due to the low interest rate on your accounts, the opportunity to earn more is not great. You will better increase the value of this money in projects such as expanding production, streamlining processes or launching a new product on the market. These definitely bring a higher return than the money left in the company’s current account. Cash reserves are a relatively expensive solution. Strategic liquidity management is therefore about minimizing the amount of cash that a company needs to keep its normal business activities running. 

What is the power of liquidity management? 

The essence of liquidity management is to ensure a long-term balance between income and expenses. A basic prerequisite for effective liquidity management is to have a good plan. Ideally a set of plans for different time periods and different levels of detail. Regular work with them will ensure that all due liabilities are paid in time and also that there will be no need to keep high reserve balances in current accounts. 

Reliable cash flow planning makes it possible to reduce the need to draw operating loans. Whether it is an overdraft or revolving credit, you will save funds associated with remunerating the bank for their use in the form of interest. In addition, knowledge of future cash flows helps increase certainty when deciding on planned investments, which is a significant advantage for financial management. Thanks to strategic liquidity management, you can more easily use discounts for early payments from suppliers. You will also better hedge against the exchange rate risk thanks to a more accurate plan of income and expenses in foreign currencies. 

The key to more accurate cash flow planning 

Two-thirds of companies consider unreliable receivables and inventory planning to be one of the main reasons for the inaccuracy of their outlooks. The key is therefore the management of working capital. You can imagine working capital as cash tied up in inventories of goods, materials, work-in-progress and finished products, but also in receivables, and it is also money in an account or the treasury. Working capital management therefore involves activities related to the management of inventories, trade credits and cash. Working capital management affects all parts of the company from purchasing, through production to sales and logistics. While financial resources tied up in inventories, receivables and current accounts make production and sales managers worry less about supply and sales, they, on the other hand, increase the demands on the volume of interest-bearing capital. In order to increase efficiency and strengthen the company’s competitiveness, it is therefore necessary to strive for the greatest possible turnover of individual components of working capital. 

Efficient companies can plan the amount of their inventory. This translates into more accurate purchase and selling planning. The strategy involves the automation of the order, invoicing and payment cycle on the purchase side. This ensures timely and reliable information on the amount and timing of future payments. It is also advisable to have efficient processes set up for receivables management, which will allow you to better estimate collection dates. Think about procedures leading to fast order processing, payment matching, monitoring of overdue receivables and an effective reminder system. As a result, standards for settling complaints and disputes with customers also lead to faster collection. Repeatable procedures are effective. Therefore, don’t forget to take only such measures that are sustainable for you in the long run and will continue to work in the future. 

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Article author: Pavlina Vancurova, Ph.D. from  Padia

Ing. Pavlína Vančurová, Ph.D.

In cooperation with Pavlina Vancurova, Ph.D., specialist in business economics from consulting firm PADIA, we have prepared the Caflou cash flow academy for you, the aim of which is to help you expand your knowledge in the field of cash flow management in small and medium-sized companies.

In her practice, Pavlina provides economic advice in the area of financial management and setting up controlling in companies of various fields and sizes. In 2011, she co-founded the consulting company PADIA, where she works as a trainer and interim financial director for a number of clients. She also draws on her experience as the executive director of an international consulting firm. She worked as a university teacher and is the author of a number of professional publications.