Failure to address cash flow problems can create dangerous situations that can be avoided.
Working capital is the key to closing the cash flow gap
Working capital is calculated as current assets minus current liabilities and gives a good indication of the liquidity of the organisation.
Making careful working capital calculations is critically important. Without knowing how much money you need to run your organisation on a daily basis, you can quickly find yourself in a cash flow crisis.
Working capital is a crucial ingredient to running a business or non-profit organisation. The working capital turnover ratio measures how efficiently you use your working capital to produce sales.
A higher ratio indicates greater efficiency. In general, a high ratio can help your operations to run more smoothly and limit the need for additional funding.
Usually, inadequate working capital is at the heart of the cash flow gap problem as the business does not have sufficient capital in the business to run the business well. In the meantime, there are many actions you can take to bridge the cash flow gap while seeking further funding.
Reduce the time from billing to receipt of payments (accounts receivable)
- Ensure the terms of sale are clearly understood and agreed to before delivery.
- Invoice as soon as possible after delivery rather than waiting for month’s end.
- If payment is not received by the due date, initiate a collection procedure based on your clearly written policy.
- As an alternative, you might look into debtors financing (also called factoring, or selling invoices) which a way to borrow against the expected income and receive immediate cash.
- Ensure all you people understand that when you have provided the goods or services on time, you are entitled to be paid on time.
Use just-in-time inventory control
- An inability to sell down inventory is a sure sign that your cash flow might be heading for trouble. If your business requires inventory or supplies, know the turnaround time from order to delivery for each supplier. Allow a margin of error, but make it your policy to keep your inventory storage time to a minimum.
- Stay in touch with marketplace trends so you don’t get stuck with items that are past their use-by Track the market life of each product.
- Dispose of dead or slow moving stock, turn it into cash to put into fast moving stock, it won’t make money sitting on the shelf.
- Keep an ageing list of your inventory, this will help to stop things getting out of hand.
- Be careful about ordering just in case someone might need it.
Know your business cycle and plan accordingly
- Plan your sales and inventory to handle seasonal influences.
- Most businesses have some type of cycle. By reviewing your monthly financial statements, especially over several years, you will see the peaks and valleys. For example, if you know that January will be a slow month you can look to reduce expenses or seek new revenue streams during that period.
- The key is to know in advance so you can plan well and take appropriate action.
“Sometimes I am two people. Johnny is the nice one. Cash causes all the trouble. They fight”. Johnny Cash
Cash flow forecasting
- A cash flow forecast is the most important tool for business in predicting if your business will have enough cash to support the operations of the business.
- Prioritise available cash usage. Cover your current liabilities first and then add to your reserves, even if it’s only a small amount and get into a good habit of building reserves.
- Continue to build cash reserves as you have the extra cash. Use the reserve to cover months with a shortfall. Be sure to replace cash reserves whenever possible as you never know when you will need them.
- Pay yourself first, if you don’t have ‘petrol in your tank’ you can’t perform the activities needed to successfully run the business.
- If you take a salary or regular personal withdrawal, make sure it is included in your projections so you won’t have to withhold payment to yourself just to cover cash needs.
- Good business planning and budgeting will help control your cash usage. Avoid making a decision without referring to the plan and the budget.
Revisit your Business Model and value chain
- Revisit your business model and look for areas to improve the model’s cash generating capability along with how it controls expenditure and It can be very easy for some to spend excessive time on an invention or innovation, which does not help the cash flow in the short term.
- Revisit your value chain (supply chain) and look for areas to improve pricing structures, delivery schedules and improve payment terms. Significant improvements in cash flow can be made by having extended credit, but be careful to use the extra cash flow on productive things.
Use debt as a last resort
- It’s a good idea to establish a line of credit for your business well before you need it. It is always more difficult to borrow in a cash crisis and it takes time.
- Pay back debt in accordance with loan terms to keep your credit rating in good standing. If you do have difficulty with repayments, contact the lender to renegotiate terms, but never at the last minute.
- Good budgeting practices should show your cash requirements several months ahead with some degree of accuracy. Financiers really appreciate this with their customers, as they too dislike hasty decision making, which is usually negative.
- Credit cards are a much more expensive option than loans from the bank. Your objective is to get what you might need at the lowest rate, so be careful about borrowing large amounts (or allowing your advances to build up) on a high-interest rate credit card.
Have ways to generate cash quickly
- Always work towards having adequate working capital.
- Know the customers you can ask to pay early.
- Clean out the ‘cash traps (overdue debtors and bad inventory).
- Negotiate longer credit terms with suppliers.
- Borrow against a pre-established line of credit.
- Arrange a longer payment period on accounts payable.
- Hold a sale to move slow inventory.
- Maybe you can rent some of your products, that aren’t selling.
- Factor accounts receivable if you haven’t already done so.
- Sell underperforming assets, better to have some cash than no cash.
- Rent excess space in your premises.
- Lend the business money
- Borrow from willing relatives, or friends as a last resort.
Additional financial management tips
- Track the budget to actual for both income and expenses every month.
- Revise your monthly forecasts based on actual-to-date and continually look for ways to better improve cash inflow and avoid unnecessary outflow.
- Employ specific strategies for improving the Accounts Receivable timeline and deferring Accounts Payable whenever possible.
- Maximise use of operating cash and proactively notify suppliers and creditors in a cash crisis. Do not wait for them to contact you.
- Obtain additional cash as needed through improved Working Capital management and planning.
- Having your loan applications rejected should be a red flag, your business isn’t doing well.
- It’s a good idea to investigate your own ‘credit report’ before making loan applications to see how you are being viewed by credit providers and to clear up any discrepancies.
- Use a good computerised accounting system and expect accurate reports to be on time every time.
- Upgrade your cash handling procedures.
- If in doubt, use a professional bookkeeper and accountant to help you.
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Understand the difference between profit and cash flow. I often come across people who are not financially savvy and they are confused with the difference between profit and cash flow. They are two very different things.
Your business may be generating a large profit and may be experiencing strong growth, but at the same time may not have cash to pay its suppliers. This could be due to a number of reasons, such as not collecting debts on time to bring anticipated funds into the company. They could have cash tied up in excess stock, or plant and equipment.
Alternatively, you may have substantial cash reserves but may be generating a minimal level of profit or even a loss and this can go on for years.
Once you understand that profit and cash flow is not the same thing, you can then begin to make profit and cash flow projections.
A profit projection shows how much profit you expect to earn over a given period, allowing you to address the viability of your business. However, a profit projection doesn’t provide you with a true picture of your cash position.
It doesn’t account for timing differences such as the length of time between paying your creditors and receiving payments from debtors and any capital outlays, tax payments, or purchase of additional stock or equipment.