Cash flow - tackle the challenge of balancing the books

28th of January 2015
Cash flow - tackle the challenge of balancing the books

Managing cash flow is critical to a business’s growth and survival. Your failure to effectively forecast and control liquidity issues can have disastrous implications, even if your enterprise is profitable. Hartley Milner looks at the challenges of keeping incoming receipts and outgoings in balance.

There is a board game launched in the States a few years back that exploits one of the business manager’s worst nightmares. It’s called Cashflow, and simply at the throw of a dice you can find yourself in the pink or disastrously in the red. Of course, no real business would leave such a crucial element of maintaining liquidity to chance. Would they?

Well, according to the European Commission, more than 500,000 businesses across the EU are wound up each year because of insolvency brought about by mismanagement of cash flow. And while the bulk of them are fairly anonymous SMEs, others are well-known names in their localities.

“Put simply, cash flow problems result from more money leaving a business than is coming into it at any one time,” explained Commission business trends analyst Catarina Bauer. “It’s human nature. People may love your products or services but do not like paying for them and delay parting with their money for as long as possible.

“Meanwhile, your suppliers are rapping at the door demanding you pay them their dues without further ado. Because you’re not being paid, you can’t pay them and this has a domino effect down the supply chain.

“Careful cash flow management is ensuring that there’s a balance in the timing and amounts of incoming receipts of payments with those of your costs. Adopting greater fiscal discipline is a traditional and still effective way of maintaining commercial liquidity in these still very difficult economic times.”

Cash inflows come from a range of sources: customers, investors and interest payments. The process of cash flow management is not as simple as it may seem. It involves dealing with suppliers, capital investors, customers and using cash flow forecasting to plan your spending and identify market trends.

Practically every business needs working capital in order to pay its bills and expenses on time. Goods and services have to be delivered in order to make a sale. However, a sale is not a sale if the cash is not collected.

The delay in receiving payment for sales invoices creates a cash flow gap that, if not managed effectively, could lead to turbulent times. You might think of adopting a frugal approach, but what happens to the expenses that you cannot avoid? Fixed costs such as rental for premises, wages and equipment have to be paid irrespective of your company’s cash flow position.

So it is vital to bridge the gap between payment for expenses and the receipt of income. This leaves you with working capital to cover your day-to-day expenses.

Bauer set out six broad actions that a business may need to take to improve cash inflow:

• Increase your sales and profitability
• Request early invoice payments
from customers
• In cases where debt is outstanding, chase customers promptly
• Seek credit facilities at favourable terms
• Invest any available cash reserves into the business
• Negotiate the right deal with suppliers.

And if you are looking to grow your business, invoice finance could release the working capital you will need. As a funding facility, it provides a solution to each of the six essential actions above. It is an arrangement with a finance provider where a business receives up to 95 per cent of the cash locked up in outstanding invoices, typically within 24 hours of raising the invoices. You receive the remaining invoice value balance once your customer settles their invoice.

You no longer have to wait 30-60 days, or even longer in some parts of Europe, to get paid by customers and you do not have to worry about your customers paying early – funds released are a cash advance against monies already earned. The debt collection function could be outsourced to the finance provider via a factoring arrangement. However, if you feel comfortable chasing your debtors or have existing credit control systems, an invoice discounting arrangement grants you 100 per cent control over your sales ledger.

The funds released via invoice finance boost your bargaining power and allow you to benefit from early supplier discounts and offers. With bank loans across the EU still ranging from miserly to non-existent, this tool could give your business the stimulus in needs to really take off.

Although cash flow may not necessarily be an indicator of profitability, there is a direct link between low profits or losses and cash flow problems. Remember – most loss-making businesses do eventually run out of cash.

Other possible causes of cash flow issues include:

Over-investment in capacity: This happens when a business spends too much on production capacity. Factory equipment that is not being used does not generate revenue, so is often a waste of cash.

Too much stock: Holding too much stock ties up cash and creates an increased risk that it become obsolete and cannot be sold.

Allowing customers too much credit: Offering credit to customers is a good way to build revenue, but late payment is a common problem and slow-paying customers put a strain on cash flow.

Over-trading: This occurs where a business expands too quickly, putting pressure on short-term finance. For example, a retail chain might try to open too many stores too quickly before each starts to generate profits.

Seasonal demand: Predictable changes in seasonal demand create cash flow problems – but because they are expected, a business should be able to handle them.

“The best way to improve cash flow is to have a reliable and up-to-date cash flow forecast,” Bauer continued. “This provides the information which highlights the main cash flow issues.

“A business uses a cash flow forecast to identify potential shortfalls in cash balances. For example, if the forecast shows a negative cash balance then the business needs to ensure it has a sufficient bank overdraft facility. It is a helpful aid to see whether the trading performance of the business – revenues, costs and profits – turns into cash, and to analyse whether the business is achieving the financial objectives set out in the business plan, which will almost certainly include some kind of cash flow budget.”

Plus cash flow forecasts help:

• Ensure that the business can afford to pay suppliers and employees. Suppliers who do not get paid will soon stop supplying the business – it is even worse if employees are not paid on time.

• Spot problems with customer payments. Preparing the forecast encourages the business to look at how quickly customers are paying their debts, though this is clearly not a problem for businesses such as retailers that take most of their sales in cash/credit cards at the point of sale.

• Aid financial planning – the cash flow forecast is an important management process, similar to preparing business budgets.

• Keep external stakeholders such as banks happy. Certainly, if the business has a bank loan, the bank will want to look at cash flow forecasts at regular intervals.

Ease problems

And Bauer suggested the following specific actions that management can take to ease cash flow problems:

Cut costs: By far the most effective method of improving cash flow. Every business can identify savings in non-essential costs if it looks hard enough. The recent credit crunch and recession has shown that businesses can take drastic actions to cut overheads and other costs, which immediately reduces cash outflows.

Cut stock: Reduce the amount of cash tied up by buying and holding raw materials or goods for resale. This can be achieved by ordering less stock from suppliers and/or offering discounts on stock held to encourage customers to buy, ideally for cash.

Delay payments to suppliers: A dangerous game, but widely used in business. By taking longer to pay bills, a business can reduce cash outflows, though at the risk of damaging relationships with suppliers.

Reduce the credit period offered to customers: This is easier said than done. By asking customers to pay for their purchases quicker, a business can accelerate cash inflows. However, there is no guarantee that customers will agree. They may need to be given a financial incentive, such as a prompt-payment discount.

Cut back or delay expansion plans: Many of the biggest cash outflows occur when a business is expanding, perhaps opening new offices or shops or adding a production line. By delaying this expansion, cash can be conserved in the short-term.

“Cash flow is the life-blood of all businesses, particularly start-ups and small enterprises,” said Bauer. “As a result, it is essential that management forecast what is going to happen to cash flow to make sure the business has enough to survive.

“This is all-critical because if a business runs out of cash and is not able to obtain new finance, it will become insolvent. It is no excuse for management to claim that they didn’t see a cash flow crisis coming.”


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