Managing your Cashflow

Managing Your Cash Flow

You can't run a business without cash. A business can be very profitable but without a healthy cash flow, it will not be able to survive in the long run. You can probably manage your finances when it is a one-man show but cash flow gets complicated as your business grows - to hire more workers, to stock up inventories and to chase customers for payment.

A simple rule of thumb in managing your cash flow is to delay outflow of cash as long as possible and expedite collections from your customers as fast as possible.

You must first work out a cash flow budget which captures all the estimated cash receipts and the estimated payments each month. The estimated cash receipts will depend on sales that are achievable based on your current capacity and orders. The estimated payments are dependent on your commitments to suppliers and staff salaries. If you are experiencing cash flow difficulties, an accurate cash flow budget will highlight, in advance, the cash deficit position that you are likely to face and hence, you will have more time to arrange for the necessary financing to tide you over the period with cash shortfalls. Cash flow budgeting also helps you to determine whether your business is viable in the long run.

Cash flow budgets are not meant as glimpses into the future. They allow business owners to plan ahead by identifying and tabulating all significant cash inflows relating to sales, new loans, interest received, proceeds from share issues and asset disposal, etc. Business owners can then analyse the timing of expected payments relating to suppliers, wages, other expenses, capital expenditure, loan repayments, dividends, tax, interest payments, etc.

During the planning process, business owners should also take into account any seasonal sales fluctuations to properly reflect the cash flow requirements over different months.

It is always critical to know what you are spending and when each dollar will be spent. A cash flow budget enables you to determine the months in which you anticipate a shortage of cash, and allows you to manage the shortfall in time.

For example, if you need more funding to grow the business, you can arrange for a line of credit with your banks before you encounter the actual cash shortfall. If you start seeking loan when you are experiencing strain in your cash flow and have defaulted in loans, your credit standing will be greatly compromised.

A cash flow budget is hence a useful management tool to control and improve the expected cash flow position of your business.

Profit versus Cash Flow

Profit is not equal to cash flow. A company that is generating cash does not mean it is making a profit, and vice versa. Profitable businesses have been known to fail due to failure in proper cash flow management.

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So what is profit and what is cash flow?

"Profit / Loss" is the calculation of how much money you have made or lost after deducting all your business expenses. However, at the time of sale and/or delivery of goods, you may not receive full payment yet. Profit and Loss includes income that you have billed but may not necessarily be collected, and expenses that you have been incurred for which you may not necessarily have paid for it yet.

"Cash flow" may be simplified as the difference between cash inflows and outflows of your business. Many business owners make the mistake in thinking that if they have cash in their bank accounts, their business are running profitably. Or if their Income Statements show profits, they assume that the cash will increase. These may not be true.

For example, you have made a sale and delivered the goods to your customer. Your customer is unable to pay you in full and asked for instalment payment. While your customer is unable to pay you in full, you will need to pay for your supplies, workers' salaries, loans and other expenses. Your income statement may show a profit from the sale, but your business may actually be running out of cash!

Example illustrating the differences between Profit and Cash Flow:

Let's look at a simple example. We assume that Entrepreneur 1 and 2 below take over the running of the business below and both are able to achieve same level of higher profits.

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Entrepreneur 1

Average collection period deteriorated from 90 days to 120 days; while average stock holding period and the average creditors' payment period remained at 120 days and 60 days respectively. By allowing the customers to stretch the payment period by 30 days, Entrepreneur 1 recorded a cash shortfall of about S$3.6 million from operating activities although the income statement reflected a profit of S$2.4 million.

Entrepreneur 2

Entrepreneur 2 was able to better manage the debtors and he was able to reduce the average collection period from 90 days to 60 days. He also has better stock management system which shortened the stock turnover days from 120 days to 90 days. With improvements in managing the debtors and stocks, Entrepreneur 2's cash flow position showed a net cash surplus of about $3.2 million, which is higher than the profits of $2.4million.

The above illustration shows that profits do not necessarily coincide with cash flow. The same profitable business operated differently may end with different cash flow position.

Some of the things that a business owner can do to manage the business cash flow are:

1. Monitor the cash flow - Create a rolling 12 months cash flow budget and forecast. For the immediate 2 to 3 months, the cash inflows and outflows should be supported by actual cash outlay commitments and expected collections from recorded sales or expected sales. Beyond the initial periods, the cash flow projections would be based on the plan of the business owner.

2. Constantly look into areas where profits can be improved - the more the business makes, the greater the base to increase cash flow. Instil a habit of constantly looking at ways to increase sales, reduce your buying price and manage your operating costs.

3. Bill faster and make a conscious effort to collect faster - Ensure that billing your customers on a timely manner is the top priority of your sales support staff. Have a system in place to ensure that your customers are being reminded to process payments for bills that are due. Seize every opportunity to negotiate with your customers for better terms, such as getting an advance payment from a customer or to progressively bill based on certain milestones, especially if the goods are customised to the specific needs of the customer and cannot be sold easily should the customer fails to take delivery of the goods.

4. Increase the turnover of your stock - Find ways to order just-in-time or carry stocks that have faster turnover. Have a system to monitor what you have in store to ensure that you do not over-stock. Find ways to sell your slow-moving items faster, such as bundling them together with the sought-after items in a sale or promotion.

5. Manage the procurement process - Stay away from complacency and be on a look out for alternative sources of supply that can be cheaper and better. Don't forget to maintain good relationships with your suppliers as if they can stretch to provide you with better terms and longer credit period, they are going to be your best "financier".

6. Plan ahead and have financial management discipline - Plan ahead and ensure that you are in control. Raise money ahead of your business needs, spend only where necessary and invest in productive assets that can generate more business and cash. Strive to deliver what you promise as only then; your financier, your employees and your customers will be more willing to back you up in time of need.

Conclusion

Business owners should always keep this in mind: "Profit and cash flow are two different concepts and they do not necessarily go hand-in-hand". It is important to be in control of your cash flow, and by implementing effective strategies, you can achieve optimum results for your business.