The term “Cash is King” rings true and is crucial for the survival of any business. Statistics have shown that 80% of businesses fail in their first three years due to a lack of support. Poor cash flow management is at the top of the list of issues that require support.
What is cash flow management?
In theory and simply put, cash flow management is:
- Cash coming into the business as early as possible,
- Cash exiting the business as late as possible,
- Keeping an eye on the future and planning accordingly and,
- Ensuring the numbers make sense.
Why do businesses struggle with cash flow?
- Business owners make decisions that are only based on their bank balance
Imagine that your bank balance is a large, delicious home-baked pie and that you are expecting guests for dinner and aim to serve a satisfactory piece of pie to each person. The question you now have to answer is, how do you ensure that everyone is satisfied?
To find the answer you have to consider the following: Who are the stakeholders in the business that need a piece of the cash pie? How big should each slice be? In to how many slices do you need to divide the pie? How big should the pie be? Do you need to bake more pie?
It all comes down to proper cash planning. Cash flow management does not just happen by chance. Careful planning is essential.
- Customers are not paying on time
In this day and age with fantastic cloud-based accounting technology, cash flow management is an easy problem to solve. Online invoicing, automatic invoice reminders and online payment optionshave decisively proven that more customers pay on time.
The first step in solving this problem is to ensure that monies owed to the business come into the business as early as possible. To achieve this you need to set your invoicing structure up in such a manner that you receive timeous payment from customers.
- Suppliers are paid too quickly
Everyone is planning their cash pie and want their slice as soon as possible. However, sometimes you have to fight for your piece. Be prepared to communicate, and if need be, negotiate payment terms with your supplier. Choose an option that will best suit your business needswithout ruining the business relationship.
Subsequent to this negotiation you need to plan and prioritise your payments according to your business’ requirements. This will reduce your stress and realise your payroll commitments.
- Seasonality is not taken into account
If, for example, your business sells ice cream, there is a high probability that people will eat less ice cream during the winter months, thus your sales will decrease. On the contrary, during the summertime, your sales will increase exponentially and your business will boom.
In this example, it is imperative to, like the squirrel, put cash away during the summer months so as to provide for the leaner winter months when sales are down. In so doing, you will ensure that your business comfortably stays afloat during quieter times.
- Failing to plan for tax payments
Tax planning is not always fun to discuss, but when the tax man knocks on the door, you want to be prepared and not suffer a heart attack. The sooner you make peace with having to pay tax and make proper provision for it, the sooner you will start to enjoy running your business.
- Unexpected expenses
There should always be an extra slice of pie dedicated to a large or unexpected expense. Business is unpredictable and things never go 100% according to plan. Never have just enough money to scrape by, make sure to build a buffer for those unforeseen events.
Solutions to overcome cash flow problems
- Open separate bank accounts
For many business owners, this is an easy and very practical step to start managing cash better. Start by opening a separate bank account,for the purpose to save for tax payments. Create a rule in the business that every time a client pays you, you will transfer a certain percentage to the tax savings account.
By doing this, you remove your tax money from your regular day-to-day business bank account. This will give you peace of mind that the money left in your day-to-day account is available to use as and when required.
You can open bank accounts for different purposes. For instance, if you have to pay staff bonuses at the end of the year, you could initiate an account and save specifically for this purpose.
- Prepare a cash flow forecast
This is a difficult exercise, since predicting the future is not easy. However, the business owners that put in the time to do cash flow forecastsknow what to expect each month and reap the added benefit of having peace of mind, knowing that all outflows are provided for.
Cloud accounting software makes this calculation easier, more understandable and accurate.
- Review your numbers
- High overhead expenses
Overhead expenses are the costs of running a business that is not tied directly to selling a particular product or service. Examples of overheads expenses include items such as rent, telephone, utilities, etc. Sometimes overhead expenses get out of hand relative to the revenue of the business. High overhead expenses can hurt your business’ cash flow.
High overhead expenses are particularly challenging because they are persistent. These expenses affect your cash flow on an ongoing basis and will continue until the problem is corrected.
To address the problem you need to page through the overhead expenses on a regular basis and make sure each expense is still relevant and necessary for your business.
- Insufficient gross profit margins
Small businesses sometimes sell their products and services atsuch low prices that they have little, or negative, gross margins. This scenario often happens in highly competitive environments with constant pricing pressures. It usually affects small business owners who do not have a clear understanding of their costs.
To address the problem, you need to go through all your products and services and calculate the gross profit margin for each. Next, you need to check where you can possibly raise prices. If you can’t raise prices, see whether you can cut back on costs without compromising quality.
- Too much bad debt
Bad debt occurs when you sell a product or service to a client who does not pay. Bad debts cause clear harm to your cash flow and your profitability.
Make sure the take-on process of new customers is strict and that you obtain credit scores before selling to a customer on credit. Invoice reminders can also be a big help to get customers to pay on time.
- Excess inventory
This problem can affect companies that manufacture goods as well as companies that resell goods. In both instances, warehouses are stocked with the product and if too much of the product is placed in stock and the stock turnover is too slow, the product ends up sitting on the shelf tying up cash and hence affecting cash flow negatively.
Fine-tune your inventory so that you only keep the minimum amount of stock for both the manufacturing and resell operations. The amount of product you keep in stock ideally depends on your sales volume, sales forecasts, available cash, and supplier capabilities.
Monitor inventory levels carefully. Having key products out of stock is a sure way to lose clients.
Think about cash flow regularly
Eat your frogs early in the morning.
Don’t put cash flow management off to deal with later. Get it done today and have peace of mind.
If you have any questions or require support with cash flow management please contact your Accountant or Financial Manager at Creative CFO. Alternatively, if you are interested in receiving services from Creative CFO please get in touch.