Effective management of cash-flow is a key issue for growing organisations. One of the most common downfalls of growing businesses is unexpectedly high running costs. What is important is not just the size of operating costs, but the cash-flows around it.
In order to stay in business, it’s important to have the fundamentals right. Managing the cash-flow of your business is a critical fundamental. Cash is literally the lifeblood of the business. If a business isn’t adequately capitalised, it won’t survive. There are frighteningly many small business owners who do not understand their cash-flow statement. A shocking fact considering that all businesses essentially run on cash. Some business experts go so far as to say a healthy cash-flow is event more important than your businesses ability to deliver goods and services! You may find that perspective hard to swallow, but consider this – if you fail to satisfy a customer and lose that customer’s business, you can always work harder to please the next customer.
But if you fail to have enough cash to pay your suppliers, creditors, or your employees, you’re out of business!
Most businesses experience cycles of good and bad times, growth and retraction. Without accumulating a ‘war chest’, the business will be unable to survive downturns. Further, without reinvesting earnings, the company will be unable to exploit opportunities of good times by financing expansion.
Analysing your cash-flow
The sooner you learn how to manage your cash-flow, the better your chances for survival will be.
Furthermore you will be able to protect our company’s short-term reputation as well as position it for long-term success.
The first step towards taking control of and properly managing your company’s cash-flow is to analyse the components that affect the timing of your cash inflows and outflows. A thorough analysis of these components will reveal problem areas that lead to cash-flow gaps in your business. Narrowing, or even closing these gaps is the key to cash-flow management.
Some of the more important components to examine are:
Accounts receivable represent sales that have not yet been collected in the form of cash. An account receivable is created when you sell something to a customer in return for his or her promise to pay at a later date. The longer it takes for your customers to pay on their accounts, the more negative affects there will be on your cash-flow.
Credit terms are the time limits you set for your customers’ promise to pay for the merchandise or services purchased from your business. Credit terms affect the timing of your cash inflows. One of the simplest ways to improve cash flow is to get customers to pay their bills more quickly.
A credit policy is the blueprint you use when deciding to extend credit to a customer. The correct credit to a customer. The correct credit policy is necessary to ensure that your cash-flow doesn’t fall victim to a credit policy that is too strict or to one that is too generous.
Inventory (or Work in Progress WIP)
Inventory describes the extra merchandise or supplies your business keeps on hand to meet the demands of customers. WIP is the value of work that has been completed on a job, but not yet billed to the client. An excessive amount of inventory/WIP hurts your cash-flow by using up money that could be used for other cash outflows. Too many business owners buy inventory based on hopes and dreams instead of what they can realistically sell. Keep your inventory or WIP as low as possible.
Accounts payable and cash-flow
Accounts payable are amounts you owe to your suppliers that are payable sometime within the near future, ‘near’ meaning 30 to 90 days. Without payables and trade credit you’d have to pay for all goods and services at the time you purchase them. For optimum cash-flow management you’ll need to examine your payables schedule.
Some cash-flow gaps are created intentionally. That is, a business will sometimes purposefully spend more cash to achieve some other financial results. For example, a business may purchase extra inventory to take advantage of quantity discounts, accelerate cash outflows to take advantage of significant trade discounts or spend extra cash to expand its line of business.
For other businesses, cash-flow gaps are unavoidable. Take, for example, a company that experiences seasonal fluctuations in its line of business. This business my normally have cash-flow gaps during its slow season and then later fill the gaps with cash surpluses from the peak part of its season. Cash-flow gaps are often filled by external financing sources. Revolving lines of credit, bank loans, and trade credit are just a few of the external financing options available.
Now that you have considered how your business practices affect your cash-flow, you are ready to develop some additional strategies for dealing with, narrowing or closing cash-flow gaps. The answer lies in how you respond to the following questions:
Do you have:
- A proper set of accounting records, the preparation of which is at least supervised by experienced accountants?
- An accurate (daily) cash book reconciled with the bank statement? Xero or MYOB-Live are great for this
- A monthly statement showing profit performance and the working capital position?
- Basic debtor controls and creditor payment controls in the hands of a responsible manager or employee working in the business?
- A regular forecast of cash requirements based upon planned sales volumes?
- Monthly ageing of debtors/creditors with comparisons to previous months?
- Close monitoring of slow moving stock, Work In Progress and monitoring minimum stock levels?
It is often worth obtaining professional assistance to set up such a system. The initial investment is repaid quickly and the costs of running it are relatively low if the system is established properly in the first place. Apart from giving a business the best chance of survival, this approach will give confidence to financiers and will certainly provide the information to negotiate funding.[/vc_column_text][/vc_column][/vc_row]