Cashflow is generally acknowledged as the single most pressing concern of small and medium size businesses. Business owners eventually realize its effects are real, immediate and, if mismanaged, totally unforgiving.
Both profitable and unprofitable companies can suffer from the malady of insufficient cashflow. It is possible to forecast a substantial profit for the year, yet still face times during that year when the company is strapped for cash.
Business owners rarely force their cash to work as hard as they do. Typically it is the laziest asset they have (with the second laziest being inventory).
A business can survive for a short time without sales or profits, but without cash it will die. The sad truth is, more businesses fail for lack of cash than for want of profit – and yet failure is avoidable!
What is the principal reason businesses experience cashflow problems? – Management fails to identify, in advance, when the problem will occur, how large the problem will be, and then fails to develop and execute a plan to prevent it. Instead, management just lives day to day and hopes somehow things will improve in the near future. This failure to effectively utilize methods, systems, and controls in managing the financial matters of the business results in:
• Incorrect pricing policies and sales mix
• Ineffective sales planning and control
• Ineffective purchasing and inventory control
• Excessive direct and indirect costs and overhead, and
• Ineffective billing, credit, and collection systems
Any one of these by itself could be enough to cause a company to fail, but typically the death knell comes from the business being poisoned by a minimum of four of the six.
The cause of cashflow problems is relatively obvious, cash outflows and inflows seldom occur together. More often than not, cash inflows lag behind cash outflows, leaving the business short of the cash required for day to day operations. Most business owners realize they need more cash when they are unable to pay their bills, have insufficient credit to buy the materials needed to fill customer orders, and are unable to cover their payroll. Psychologically they feel hopelessly caught in a “Catch 22” … but there is a way to change this apparently hopeless situation.
You start by identifying and quantifying the problem(s) with a cashflow forecast (a ‘control’). Then, install ‘methods’ and ‘systems’ to correct the problem(s). Cashflow forecasting enables a business owner to predict peaks and troughs in the company’s cash balance. The anticipated cash receipts flowing into the company and the dates upon which bills are due must be tracked on a week-by-week basis for a minimum of 6 weeks into the future, as well as month-by-month throughout the year. Constructing a spreadsheet that provides this information is a relatively simple task, and will identify when the problem will occur, the size of the problem, and the extent of corrective action necessary.
Always be mindful of the underlying premise of effective cash management:
Cash is not freely given. It is not the passive, inevitable outcome of business endeavors. It does not arrive in bank accounts willingly. It has to be tracked, chased, and captured.
The secret to operating a business with the least amount of cash is to maximize the speed at which money moves through the cashflow cycle and minimize the amount of money tied up in inventory and uncollected receivables.
Here are some examples of where corrective action can be applied to generate immediate results:
• Sales – Increase sales (especially those paid in cash), increase prices to slow payers, rate payment performance of large customers (those representing 80%+ of sales) and aggressively pursue them – they control most of the business’ money, be more selective in granting credit, require deposits and progress payments, reduce payment time and customer credit limits, etc.
• Purchasing – Pay suppliers on invoice due dates or slow pay where possible, take volume purchase credits if advantageous, negotiate extended credit from suppliers, barter to acquire goods and services, only pay promptly when worthwhile discounts apply, etc.
• Inventory – Return or sell off obsolete and/or excess inventory, institute just-in-time inventory control and tracking systems, streamline work-in-process, etc.
• Credit & Collections – Invoice customers as soon as work is completed or orders are filled, generate receivables aging reports for use in collections efforts, establish and enforce employee adherence to sound credit practices, add late payment charges, use proactive collection techniques, etc.
• Financing – Renegotiate with banks and lenders to reduce charges, extend debt repayment periods, defer dividend payments, convert debt into equity, raise additional equity, install cashflow forecasting, utilize factoring or discounting to accelerate receipts from sales (as a last resort), etc.
• Investment in business – Defer all capital expenditures, sell off surplus assets or make them productive, lease or enter into sale and lease-back arrangements for producing assets, defer projects not capable of achieving acceptable cash paybacks, etc.
Sound simple? The difficult part is structuring seamless, simplistic, and harmonious systems, methods, and controls that can be effortlessly executed by employees with a minimal amount of training … but the rewards are tremendous – well worth the effort.
© 2004 Kenneth Sweet - Kenneth Sweet, JD, is the Executive Director of Management and Tax Consulting at the largest privately-held business development company for small to medium size business in North America, and a leading authority on small business.
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