By Raymond Gibbons, 1st April 2011
As business people, we are all aware that it is cash that is the real lifeblood of any business. That old saying, ‘revenue is vanity, profit is sanity, but cash is king’ has never been more pertinent. Access to easy credit lines appears to be a thing of the past, for the immediate future any way that is. While all too many companies have also seen a severe drop in revenues which has not been matched in a reduction of overheads.
As a result, SME’s, in particular, are having great difficulty in managing ever-tightening cash flows, be it from customers lagging on payments or a lack of lending facility from a stressed banking sector.
The importance of cash flow management, therefore, has never been more critical. However many of the issues of poor cash flow management stem from companies operating for too many years when there was a constant stream of easy cash available and they took their eye off those internal systems and procedures which act as a barometer for good cash flow management.
Cash Flow Management
Cash flow management is effectively about managing the cash coming into your business and the cash going out. It is about getting the balance right to ensure you receive cash owed to you before you have to pay for your overheads. The danger is very evident.
All too often cash inflows seem to be slower at coming in than the speed with which you are paying out cash. This shortage of cash flow gap is generally fine provided you are trading profitably and receiving in more cash from customers than you are paying out to suppliers over a period of time i.e. after receiving payment from customers and paying out your suppliers there is a balance of cash remaining to be re-invested in the company.
However, this is not always the case and cash flow needs to be monitored and projected forward to highlight potential cash shortfalls. By careful monitoring of your cash position, corrective action can be taken in advance to ensure you are able to manage difficult times more easily.
Cash flow, therefore, can be described as a cycle. The cash you use in your business to acquire resources to sell products or services to your customers is then collected by way of customer payments. These payments are used to pay outstanding bills you have and also to re-invest in more resources to sell additional products or services.
Working capital is the amount of cash tied up in the business’ trading assets. Calculated as (Stock + Debtors-Creditors), a negative working capital might indicate a business’ inability to pay its short-term debt.
What is more relevant is the connection between the three items above. Cash tied up in Stock and Debtors is a cost to the business. Effectively managing your stock means tying up less cash in expensive materials. Overstocking ties up cash needlessly and should be avoided.
Debtors, on the other hand, can seldom be avoided. Most firms offer credit terms to customers to secure their custom. Debtors are therefore the cash tied up in unpaid invoices from customers. By reducing Debtor days (speeding up payment from customers), you can cut down on this cost and bring in much-needed cash to your business.
Creditors are the opposite of Debtors. This is cash you owe to your suppliers. By lagging on these payments you may extend your own credit terms and slow down your outgoings. But be warned, obtaining a reputation as a bad payer could do untold damage to your business.
Improving your Cash Flow
Remember that cash flow is the movement of cash in and out of your business. Cash Inflows can be monies received from customers to loans from your bank while Cash Outflows will be all the costs you have incurred to sell that product or service to your customer. These can be raw materials for products, rent, wages, insurance etc.
Managing Cash Inflows
Customer Payments: One of the biggest risks to SME’s is the failure of customers to pay their account on time, if at all. Defaulting or delaying payment can impact upon your ability to secure new raw materials, meet bank repayments or to pay the wages of staff.
So how well do you know your customer base?
To safeguard against customers defaulting on payment it would be advisable to implement some or all of the following points;
- Check your customers’ creditworthiness.
- For new accounts, ask for references to check their track record on payments.
- Enforce your credit terms.
- Impose penalties for late payment.
- For new accounts insist on COD for the first two or three deliveries.
- Seek payments by Direct Debit.
- Take out credit insurance on your debtors.
- Be diligent; continuously review your aged debtors.
- Offer incentives for early payment of account.
- Phone your customers a week before payment is due to ensure there are no issues with payment.
- Construct a robust Credit Control Policy to minimise the risk of customers defaulting on their payments.
Internal Efficiencies: It stands to reason that the more efficient your own internal processes the more likely it is that your customers will pay on time. We have all heard the excuses for non-payment, some of the more common ones are;
- ‘I have not received the invoices.’
- ‘The invoices arrived too late for processing in the month and as a result will be paid in the next cheque run.’
- ‘There is an error on the invoice.’
By eliminating your own internal inefficiencies you are eliminating the range of excuses for customers to delay payment. Best practice in all your procedures will speed up cash inflows. When your customer places a Sales Order you must ensure that all the information is correct. The customer will have used the most up to date information available, so if the information on price, delivery time etc are incorrect at the start you have got off on the wrong foot. The sales order process should be quick and easy to use.
Assuming the customer has cleared your credit vetting procedures, the next step is to fulfil the order. It is critical that you honour your commitment on delivery and quality. Clearly, once you have met your obligations on delivery and quality it is so much easier to insist on prompt payment. If delays are unavoidable, keep your customer notified.
Invoice your customer immediately on delivery of the goods or at the very least within 24 hours. Ensure that the invoice has been checked for accuracy so that it matches the agreed price, that the description and quantity of goods delivered, matches not just the sales order but more importantly the delivery note should the actual goods delivered differ from the sales order.
The quality of your invoice is critical. Critical information it should contain is; your company details, customer name address, description of goods or services sold, quantity delivered, price, payment terms, invoice date, sales order/delivery note number.
And remember – Once the invoice has been raised, post it out or e-mail it immediately to the correct address!
Managing Cash Outflows
It is vital that you understand what cash outflows your company incurs. If you are cash-rich, payments can be met as they fall and in line with agreed credit terms. If your company, however, is restricted in whom it pays and when because of a worsening cash flow situation, how do you decide who to pay?
Paying a key supplier to ensure you continue to trade, on the surface seems a sound judgement call. But what of the suppliers who have gone without. Will they wait for the next payment run? Will they seek a judgement for non-payment? Will it frighten off future suppliers who hear of your difficulties in meeting payments?
It cannot be overstated how important it is for a company to develop the habit of generating cash forecasts. This will highlight expected receipts and outgoings and generate an anticipated cash position. The cash forecast should be for a three month period and updated weekly to ensure the most up to date information.
The starting point is to understand who you owe money to. Wages for your staff must be met weekly or monthly. Bank loans must be repaid. Materials must be paid for. VAT paid and so on.
Start by forecasting who needs to be paid and when. Use your creditor’s ledger to map out payment dates for suppliers. Ask yourself, how up to date is your creditor’s ledger. You could be living in a fool’s paradise if you omit significant payments to suppliers because the creditor’s ledger is not up to date. So be sure to take into account outstanding purchase orders that have not yet been matched to supplier invoices.
Prioritise payments ensuring that all critical payments are dealt with first. This may be obvious, but ensure there are funds to meet your wage bills for example.
Against these costs, map into your cash forecast expected receipts from customers. Using your opening bank balance you can now very simply generate an expected weekly bank position.
The forecast will visualise your current and future cash position and it may be possible to merely slow down supplier payments for a few days if the need arises as you know there are cash receipts due in presently.
However, the risk here is that you may establish a reputation for late payment and that creditors will impose stricter and shorter credit terms if you persist with late payments.
If your existing cash flow difficulty is more longterm, what can you do?
Firstly as mentioned, have a detailed cash flow forecast available to highlight the current gap in funds and therefore the funds you require to close this gap.
Secondly, develop a business plan to show the viability of your business. Your bank will want this detailed plan to satisfy there own risk assessors that your business is worth investing in.
Thirdly, be open and transparent in your dealings with lenders, without giving away your competitive advantage.
You can then;
- Approach your bank for support.
- Increase your overdraft limit.
- Secure a short term loan.
- Apply for invoice discounting.
- Speak to your principal suppliers and agree on a payment plan.
- Speak to the Revenue Commissioners if meeting your tax liabilities for VAT or PAYE is a problem.
- Seek extended credit terms from suppliers.
- Speed up cash inflows by offering incentives for customers to pay early.
- Reduce and eliminate unnecessary costs.
- Inject additional personal cash.
And of course what you should not do
Do not bury your head in the sand and ignore the warning signals. As payment reminders come across your desk, deal with them personally. Communication is vital. It is in no one’s interest for you to default on payment.
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Disclaimer This article is for guidance purposes only. It does not constitute legal or professional advice. No liability is accepted by Company Bureau for any action taken or not taken in reliance on the information set out in this article. Professional or legal advice should be obtained before taking or refraining from any action as a result of this article. Any and all information is subject to change.