So, What CAN you DO about Cash Flow?

 

Further to my recent post about cash flow, my client asked me what their company could do if they thought there was a risk of over trading and have a cash flow problem?

Just to recap, the problem of fast growth is that you need to produce more goods or deliver more services and the timing between paying your suppliers and creditors and your receipt of funds from your clients creates a funding gap and a cash shortage.

Using the Six Minute Strategist methodology, let’s look at this under six headings

Assets

As assets build up they suck in cash. So to mitigate the problem you need to reduce the build up of assets.  How can you do this?  One solution is simply to sell less but this could do long term damage to your business. It is better to try to negotiate better terms with your customers. This might include asking for some payments in advance or agree shorter payment terms, 14 days rather than 30 perhaps.  Faster payments leads to better cash flow.

Liabilities

If you are paying any of your suppliers in advance or quickly, arrange to extend your credit terms perhaps to 60 days from thirty or stage your payments to them.  In any event, where you can you should avoid paying in advance for any services.

Prepayments is a slight anomaly as a prepayment is a source of cash, a customer has paid you in advance for goods and services to be provided in the future.  However under UK accounting rules as you don’t actually own the money until you fulfil your side of the contract and so it is accounted for as a liability.

Clearly while you need to pay your taxes on time, including Corporation Tax, VAT and PAYE, if you are in difficulties you can discuss this with the taxman (at least in the UK) and try to negotiate for some more time.   For other liabilities, you can negotiate with your landlord or electricity company for example to extend the timetable of the payments you owe them.

The clear message here is that TIME above all is your enemy.

Funding

If the first two steps do not solve your problem, you should consider how you might get additional funding into your business.  This might involve a discussion with your bank manager to get an overdraft or a short term loan.  If your problem is caused by a large order you might be able to turn to factoring or invoice discounting.  In essence, the bank or a finance house pays you the value (with a small discount) of your outstanding invoice and collects the cash themselves a little later.

If the Bank cannot solve the problem, your business may need some additional capital in the form of debt, a convertible or equity from either existing shareholders or third party investors.  The former can be faster but raising capital from new investors can take between three and six months.

One of your last resort solutions is to try to use your credit cards to provide some liquidity.  This is expensive and a very short term solution and not one I would recommend.

Ratios – Watching the Trend

In my first blog post, How do you Account for Cash?  I explained the three ratios which help to keep a close eye on the health of your working capital. The Current Ratio, The Quick Ratio and the Cash Flow Ratio.  You can go back to the original post and see the definitions there.

The important point about these ratios is not the snap shot you get on the day you calculate them but in their trends over time.  Set up your accounting system to capture this information daily and enable you to graph it or capture the ratios in your own spreadsheet and watch them over time.  You can go back to the underlying data to see why the trend is positive or negative and what parts of your working capital are having the most impact once you understand what you are looking for.

Remember the story of the frog in the boiling water, if the water is brought to the boil slowly, the frog doesn’t notice the heat going up!

Debtor and Creditor Days

This is a measure of how quickly you collect your debts and how quickly you pay your creditors and is another easy ratio calculation you can do to help you monitor your working capital.

Debtor Days – divide your trade debtors by Sales and multiply by 365.  You can also take your debtor days at two different dates, take the average of them and divide by sales and then multiply by 365.

To calculate Creditor Days – take your annual purchases or cost of goods sold (a proxy only) and use this denominator.  Divide Creditors by this and multiply by 365.

Clearly you want to be collecting your debtors faster and paying your creditors more slowly.

Be proactive – Watch the cash

The key point to remember is to manage your working capital proactively and anticipate the possibility of problems arising.  The best way to do this is to prepare and manage your own Cash Flow Forecast.  Remember that this will require a financial mode, which includes the profit and loss account, the balance sheet and cash flow.  This model must be integrated between the three and must not be circular.  Once set up you can model different scenarios and ask “What if?” questions.

If you think you are about to win a huge contract and this will put your working capital under pressure, take the initiative and take control of the situation.  Early conversations with your bank manager or shareholders to discuss how this can be funded can help prevent the problem turning into a crisis.

With customers you can try to improve the payment and delivery terms in the negotiations while you are closing the deal, but be careful not to put your customer off.

My last point here is to involve all your Staff.  Keep them appraised of the performance of the company and encourage and reward them for coming up with ways to improve business performance, profitability and cash flow.  They are in an excellent place to save money and to identify areas where further savings and efficiencies can be made.

If you like this please RT.  If you would like to receive more from me, The Six Minute Strategist, please subscribe and join my mailing list.  You can comment below or email me at john[at]jbdcolley[dot]com.  Please also go over to iTunes and you can subscribe to the “Conversation with the Six Minute Strategist“.  Thanks for joining the Conversation!

 

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