Having enough money for your day-to-day business requirements is crucial. It is what keeps your business going – and helps you sleep at night. Introducing cash flow targets at your business can help you optimise your cash flows.
What are Cash Flow Targets?
Before we define cash flow targets, let’s take a quick look at cash flow. Cash flow refers to the money flowing in and out of a business. Cash inflows may come from the sale of products or services, interest or dividends, or the sale of assets. Common cash outflows include production or procurement costs, employee pay, loans, and operational expenses.
Cash flow targets are the ideal cash reserves your business should have to hand at any moment in time. This amount must balance the amount and timing of your anticipated cash inflows and outflows against the opportunity costs of setting aside too much cash.
Why Are Cash Flow Targets Important For Your Business?
Managing cash flow is very important to a business. Even a profitable business can run into serious problems if it has liquidity problems.
Some businesses have seasonal cycles. Some make more money in the summertime while others may be doing brisk business in the winter. Depending on the products or services offered, some months may be hectic while others may be slow. Whatever the seasonal cycles of your business, it is important that there is adequate cash available to meet the demands of outflows at any time.
Knowing how much cash you will need on a daily, weekly, and monthly basis to cover outflows, with enough left over as profit margins, should be something you, as a business owner, need to be familiar with at all times. Holding on to too much cash drags down investment performance and can lead to other opportunity costs. Having too little cash means you may miss some opportunities, have liquidity problems, and potentially force you to borrow money to cover temporarily for the shortfall.
How to Set Cash Flow Targets
You should aim to estimate cash flow over a rolling 12-month cycle. Planning for 12 months into the future ensures you have enough time to save up to meet your cash flow targets at that time, while also providing an opportunity for you to assess what you need to change for the coming year.
Here are a few tips to help you set realistic and reliable cash flow targets:
Set predictable payment timelines for your customers:
Revenue from sales is not the same thing as cash flow, since you may not receive cash at the time of the transaction. By setting firm and predictable payment timelines for your customers, you can improve the accuracy of your cash flow predictions.
Use your current position to tweak your targets
As we outlined in our video explainer (above), you should set your cash flow targets at the beginning of each financial year. But you should reassess your targets at regular intervals too. With your annual cash flow targets in front of you, you can tweak your plans based on your current position to ensure you are sufficiently funded at all times and excess funds are maximised.
For example, in periods with reduced or negative cash inflows, you can look for ways to slash expenses, boost sales, or decrease accounts receivables to cover the shortfall. When cash inflows are higher, you can plan how to best spend that money to maximise growth.
Draw up multiple scenarios
The pandemic has shown the importance of planning for the unexpected. In these uncertain times, it’s best to draw up different scenarios so you are prepared for the impact of different economic conditions on your cash flows. This ensures you’re prepared to adjust your operations if this scenario becomes your reality.
Setting cash flow targets keeps your business operating throughout the year while maximising your opportunities for growth. If you’re looking for ways to boost your cash flow in the short term, read our blog post on the topic.
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