In this article we look at the key elements of cash flow management and how to protect the financial security of your business. We outline steps for dealing with customers, suppliers and stakeholders to improve cash flow and highlight some common mistakes business owners make.
Cash vs. profit
Profit is the difference between the total amount your business earns and all of its costs over a given trading period. Cash flow (inflows and outflows) is the movement of cash into and out of your bank account.Good profits do not necessarily mean your business is healthy and bad cash flow management can leave you cash strapped and fighting for survival.
To trade effectively and grow your business, you need to build up cash reserves by ensuring that the timing of cash movements puts you in an overall positive cash flow situation (inflows exceeding outflows). Income and expenditure cashflows rarely occur together (inflows often lag behind). You should aim to speed up the inflows and slow down the outflows. To improve everyday cashflow you can:
- Ask your customers to pay sooner;
- Chase debts promptly and firmly;
- Use factoring (obtain third party advance on portion of invoice);
- Ask for extended credit terms with suppliers;
- Order less stock but more often;
- Lease rather than buy equipment;
- Improve profitability;
- Increase borrowing (not to be used as long-term strategy);
- Put more money into the business (not to be used as long-term strategy);
- Set up cash flow management systems (Who is responsible for tracking cash flow? How regular should forecast be reviewed?);
- Arrange special terms with suppliers (30-day accounts, pay bills quarterly,etc.);
- Control cash outflows (Switch suppliers if necessary, negotiate once-off purchases);
- Get accounting software to track cashflow and make forecasts;
- Use forecast to spot problems;
- Bank money the instant it comes in;
- Shop around for better deals that could reduce costs;
- Monitor the effectiveness of your marketing and modify it as necessary (cash inflows).
Cash flow problems and how to avoid them
No matter how effective your negotiations with customers and suppliers, poor business practices can put your cash flow at risk. Look out for:
- Poor credit controls – failure to run credit checks on your customers is a high-risk strategy, especially if your debt collection is inefficient.
- Failure to fulfil your order – if you don’t deliver on time or to specification you won’t get paid. Implement systems to measure production efficiency and the quantity and quality of stock you hold and produce.
- Ineffective marketing – if your sales are stagnating or falling, revisit your marketing plan.
- Inefficient ordering service – make it easy for your customers to do business with you. Use first class post and, where possible, accept orders over the telephone or internet. Ensure catalogues and order forms are clear and easy to use.
- Poor management accounting – keep an eye on key accounting ratios that will alert you to an impending cash flow crisis or prevent you from taking orders you can’t handle.
- Inadequate supplier management – your suppliers may be overcharging, or taking too long to deliver. Create a supplier management system
- Poor control of gross profits or overhead costs.
Cash flow forecasting
Cash flow forecasting helps you predict peaks and troughs in your cash balance, plan borrowing and predicts surpluses at a given time. Many banks require forecasts before considering a loan. The forecast is usually done for a year/quarter in advance and divided into weeks/months. The forecast lists: Receipts, payments; excess of receipts over payments – with negative figures shown in brackets; opening bank balance; and closing bank balance.
Established businesses can combine previous 12 months sales with predicted growth to compile realistic forecast estimates. Forecast figures must relate to sums that are due to be collected and paid out, not invoices actually sent and received. Accounting software makes cashflow forecasting and planning easier and enables “what if” calculations.
Adjust forecasts in line with long-term changes to actual performance or market trends, in light of your sales, purchases, staff costs and changes in legislation, interest rates and tax rates. Having a regular review of your cashflow forecast will enable you to:
- See when problems are likely to occur and provide solutions in advance;
- Identify any potential cash shortfalls and take appropriate action;
- Ensure you have sufficient cashflow before you take on any major financial commitment.
Have a contingency plan, such as retaining a minimum amount of cash in the business in an interest-earning account, to meet short-term cash shortages.
AUTHOR: Jacques Nel heads up Indus Consulting a specialised small business and franchise consulting hub. For more information visit: www.indus.co.za.