As cash is essential for the smooth operations of businesses, one should focus on improving cash management and develop strategies to combat emergencies.
When it comes to business operations, be it small or large scale, cash is always the king. Whether a business is thriving or struggling, effective cash flow management is essential. In fact, for many businesses, it’s the key to survival. The importance of cash can be understood from the fact that over 60 percent of businesses that fail are still profitable, but they have to shut the shop as they run out of cash.
On overusing the working capital, a business can witness a cash crunch that can prevent payments to its suppliers, purchase of raw materials and salary payments to its employees. Delay between the time when a business pays to its suppliers and when money is received from the customers is the problem. This requires effective cash flow management to survive and grow. Therefore, maintaining a level of working capital, that allows a business to make it through crunch times and continue operating the business, is crucial. Simply put, cash flow management means delaying outlays of cash as long as possible while encouraging customers to pay as quickly as possible.
So, what is cash flow? It’s basically the movement of funds in and out of one’s business. Typically, businesses track cash flow either weekly, monthly or quarterly. Essentially, there are two kinds of cash flows: A positive cash flow occurs when cash entering into the business from sales, accounts receivables and so on is more than the amount of cash leaving the businesses through accounts payable, monthly expenses and employee salaries. A negative cash flow is just the opposite situation and occurs when the cash outflow is greater than incoming cash. This generally means trouble for a business.
It is not possible, however, to look at the profit and loss statement (P&L) and get a grip on cash flows. Many other financial figures feed into factoring cash flows, including accounts receivable, inventory, accounts payable, capital expenditures, and taxation. Effective cash flow management requires a laser focus on each of these drivers of cash in addition to profit or loss. Rules of accounting define profit simply as revenue minus expenses. However, a smart business owner understands the fact that whether one earned profit or not is not the same as knowing what happened to your cash. An astute businessman should know when the business will become profitable, not because it will affect the cash flow — because it won’t — but because it gives one an early goal to strive for and a ready-made target for projecting future cash flow. Negative cash flow and negative profits make for a grim combination. Focus your efforts on managing cash flow with an eye towards reaching that moment when you realise your first profits.
Since cash flows are very important for the smooth running of any business, one should always focus on improving and managing cash flow and develop strategies to manage problems:
Short-term financing: This type of business financing such as a line of credit can be used to make emergency purchases or to bridge the gap between payables and receivables. Many banks issue business credit cards that can be used to pay vendors.
Long-term financing: Large asset purchases such as equipment and real estate should usually be financed with long-term loans rather than with working capital. This allows a business to spread payments over the average life of the asset.
Speed up recovery of receivables: The main mantra of any business should be to bill early and collect quickly. To guard against late payments, bill as early as possible and make those invoices as clear and detailed as possible. Instead of waiting until the end of the month, generate an invoice as soon as the goods or services are delivered. For big orders, one can consider progressive invoicing while the goods are manufactured or services delivered. It’s easy to lose track and then neglect to follow up on an overdue account. Experience shows that the longer one remains out of contact with a customer, the less likely he/she is able to recover the amount owed. One can even incentivise customers who pay their bills rapidly by offering discounts.
Liquidate cash tied up with assets: Does your business have equipment that is no longer in use or inventory that’s becoming obsolete? Consider selling it to generate quick cash. Idle, obsolete and non-working equipment takes up space and ties up capital, which can be used more productively. Equipment that has been owned for a longer period will usually have a book value equal to its salvage value or less. So, a sale might result in a taxable gain. Excess inventory can quickly become obsolete and worthless as customer requirements change and new materials are introduced. Consider selling any inventory, which is unlikely to be used over the next 12 months, unless the costs to retain it are minimal and the proceeds from a sale would be negligible.
Delay your payables: This may sound obvious but is often neglected. Unless there’s a worthwhile incentive to pay early, figure out how late you can pay your vendors without risking late fees or harming your relationship. This keeps the cash in your account and out of your vendor’s until it absolutely has to be there.
Identify business risks and prepare in advance: There are many risks involved in running a business. Serious challenges should be expected at some point in the future. You need to consider a number of scenarios such as “What if a big order suddenly comes in?” “What if a big order is cancelled?” or “What if that important client goes missing while still owing me money”? This kind of risk analysis should become a part of the cash flow budgeting process.
Monitor inventory efficiently: Analyse inventory movement to determine which items are selling and which ones are duds that soak up working capital. Try to keep inventory levels lean so that working capital isn’t tied up unproductively and unprofitably.
Always keep buffer money: Once the break-even point is found, one must ensure that the business has enough cash to fund working capital needs. It’s advised to keep three months worth of outgoings in the bank for a rainy day. That may be a thing of the past but if that’s the case, make sure you have a buffer of some sort, either personal funds available or an overdraft or revolving credit facility.
Implement better systems to manage cash flow: Many businessmen procrastinate to invoice customers. Some do not invoice as soon as they deliver the product or services or do it just at the month end. Many do not even know how much is owed to them by their customers or how much they owe to suppliers.
If you are one of them, it’s time to start implementing an efficient process to manage cash flow. You can use a simple spreadsheet or an accounting software. But its important to have some systems in place.
Cut costs, control cash outflows: The best way to control cash flow is to stay on top of expenses. When we start making profits, we often tend to ignore cost-cutting opportunities. Unmanaged outflow could be a silent business killer.
Do not focus on profit but on cash flow: It has been found that 90 per cent of SMEs do not have a cash flow plan from day one, despite having forecasts of profit margins for years ahead. This is a common reason for early business failure. If cash flow is in order, profit will be in order. A lot of businesses do not make it past six months. They might have been a profitable business eventually but they need to have good cash flow to survive.
Young businesses should work with reliable, quick-paying clients initially, even if it means smaller clients and slimmer profits margins. Small business owners should learn one principle early in the life: Cash is king. Building and keeping an adequate stockpile of cash provides maximum opportunity and flexibility to any business while enabling its owners to sleep soundly at night.
Without cash, profits are meaningless. Many profitable businesses on paper have ended up in bankruptcy because the amount of cash coming in doesn’t compare with the amount of cash going out. Firms that don’t exercise good cash management may not be able to make the investments needed to compete, or they may have to pay more to borrow money to function.
(The writer is Assistant Professor, Amity University)
Courtesy: The Pioneer
Writer: Hima Bindu Kota