The importance of cashflow management

Cash is king: it is the bloodline of your business, a strong indicator of whether your business will be there in ten years’ time or not. It is therefore critical to get a good grasp of your business’s cashflows.

It is important for business owners to understand the difference between accounting profits and cash flow. Profits do not mean cash on hand and, more importantly, accounting profit is historical, while your monthly cash analysis informs the next business decision you make.

What your cashflow statement in your financial statements helps you understand is how you finance your daily operations, that is, whether you are using debt to finance your daily operations and not generating any sufficient cash from the business. It also helps you see if you are making any investments in the future of your business. You could be making profits, but a lot of your sales are on credit, which begs the question of whether you will be able to recover all that money.

Businesses fail to take off and grow due to cash constraints as raising capital for your business is very difficult and complex. Most entrepreneurs are not able to meet the minimum requirements for investments or funding. Most are forced to bootstrap their businesses, which means that they start with their own resources and maintain a lean/small business model with the use of internal funds to grow their businesses. To be able to do this, businesses need to develop an effective cash management plan.

AN EFFECTIVE CASH MANAGEMENT PLAN

Here are a few elements of developing an effective cash management plan:

Planning

How much do you need to run your business monthly? It is important to know what your monthly cash outflow is. You should safely be able to budget for ordinary expenditures for at least three to six months ahead, if not a year or more. This allows you to also consider what your expected cash receipts are for those months, considering the seasonality of sales and past experiences.

The use of monthly budgets enables you to plan how you are going to finance your cash needs. This way, based on expected cash receipts from customers, you can foresee if there will be any cash shortfalls in terms of commitments you have made, and you can start making plans to cover the shortfalls with short-term loans or credit. This works as well if you have a surplus: any extra cash not needed in the next three months can be put away in an interest-earning account − this will help cover some of your banking expenses.

It is important to note that budgets are not static: you need to review your cash performance against your budgets monthly. This means you need to review your budgets and adjust as the business environment changes and cash expectations change. This forward planning allows you to renegotiate terms with both customers and suppliers, as well as timeously cut or end agreements that you may not be able to fulfil.

Liquidity matching

It is difficult to control cash receipts in a business; however, businesses should at least set a payment terms policy that they use in all contracts with customers as to when they need to settle their accounts. This policy should be communicated to all customers. Often though this is difficult for small businesses doing business with large corporates, as they are often forced to adopt the payment terms of the customers. The same goes for SMEs doing business with the government: it is very difficult to have any control over when you should get paid, and often this is further complicated by process issues that may cause further delays.

Some practical tips are:

• Be vigilant with invoicing and sending out statements on time, monthly. Don’t be afraid to follow up on outstanding payments.
• Have different payment classes for all customers to spread receipts over the month, for example 7 days, 14 days and 30 days. Do the same for your suppliers (this will be 30 days after the invoice is received).
• Request deposits before delivering the good or service, where possible. This means you get to receive cash forward while you are working on delivering. You are also safeguarded in case the customer cancels or terminates the contract.

Small businesses should negotiate with their creditors/suppliers for extended payment terms, where you try to match them to when you expect receipts from customers. It is not always easy or possible, but there will be a win in some cases. The best approach is to be transparent and communicate on a timely basis to allow your suppliers time for their planning. This will preserve and strengthen the business relationship.

Leverage − the use of smart debt

Where small businesses can extend payments for services over a longer period instead of paying all at once, they should take that opportunity, especially if it comes at minimal or zero interest. There are some subscription services that organisations use where you don’t have to pay the annual fee in advance, but you can stretch over a period to preserve cash. Of course, this needs to be weighed against possible loss of settlement discounts.

Businesses should also consider the acquisition of capital assets by using debt. It is of course easier to attain debt through your banks, but if you are planning and can build yourself time before the need for the expenditure arises, it will be better to try to attain cheaper debt through development funders if you meet the criteria set by them. The repayment terms are also better, and not immediate as in the case of the banks. Suppliers, especially big corporates, allow for equipment to be purchased on credit. In these cases, when the opportunity arises, take it.

It is prudent to always review the cost of credit and compare store/supplier credit cost to the cost you would pay using an overdraft facility with your bank. There are other credit providers outside of traditional banks and other credit facilities outside of traditional credit cards or overdraft facilities. The costs need to be weighed and assessed.

In the case of capital expenditures, instalment sales agreements can be entered into and should be assessed against other lines of credit. Some facilities can be provided through enterprise/ supplier development programmes, which may be cheaper and have better repayment terms than traditional credit providers. Cheaper debt is smart debt, and extended payment terms do not necessarily mean the debt is cheaper. The interest accumulates over time, making what was originally a good deal very expensive.

When a business is heavily indebted, it is advisable to pay the most expensive debt first or fast to reduce the expense burden and cash outflow on the business. Debt is not encouraged but recommended only when the business has developed a good project pipeline and is in a good position to repay timeously.

Payroll costs

How people work is changing: people prefer flexibility and often don’t want to be tied down to one specific job. Therefore, they are freelancing and looking for part-time occupations rather than full-time jobs. Therefore, if possible, for your business and industry, consider not carrying a big staff complement but rather creating a database of contractors that you can call when you have big

orders to produce, or projects to deliver. The cost is converted from overhead to project costs. Of course, you need to consider all the pros and cons of this: you might lose some talent when needed as they might be snatched away. This principle applies to administrative tasks as well. You can outsource some functions like accounting and payroll management, HR tasks, and admin tasks, as some people have online assistants. These can also be automated/ virtual to reduce the costs of the overall service.

The one which may seem obvious is to negotiate salaries on a gross cost-to-company basis instead of a net basis. Many organisations follow this practice, but you do find that some small businesses will discuss compensation on a net-pay basis. This will be misleading as the true costs include taxes and other benefits like allowances, insurance, medical aid, etc. Consider a mixed salary structure that includes incentive pay and not just a fixed basic pay.

Cost control

The first step in cost control is looking at the company structure – the structure needs to be as lean as possible without compromising the quality of goods and services. This means automating as much as possible and outsourcing. It calls for being very innovative and futuristic in how you shape your business.

One of the big things businesses are incorporating is moving to a remote working style instead of paying for office space. There are many variations of this, with some businesses using co-working spaces as and when needed to meet clients and have quick team catchups or workshops to kick- start a project and decide on deliverables. Some are reducing the space needed with working models where not all staff or functions are needed at the same time. Of course, this will need a good investment in cloud operating systems, Internet access by all employees, and alternative power supplies.

Cost control requires a good grasp of how you spend money in your business. With the help of your accountant, you need to break down your cash flow report by classifying expenditures into different categories. For example:

• Project costs will be costs incurred or needed for the successful delivery of the project. This will often be classified as the cost of goods sold in your income statement. In this classification, you also get to split your staff time into billable hours and non-billable hours. This is where you get to understand whether projects you have embarked on are profitable or not. This way you also can start assessing how you are pricing your goods and services.
• The next category will be expenses for assets that enable the project to happen. This will include the costs of the capital assets needed to deliver on the project and people who may not be technically involved in the project but are necessary for the acquisition and delivery of the project.
• The admin costs are not all the same. Some costs are necessary for the operation of the business, like banking costs, regulatory reporting costs, training costs, professional association costs, etc. These costs can be unavoidable, while some can be delayed and spread over time.
• General admin costs are costs that can be avoided altogether for low cashflow periods and therefore need to be constantly assessed and managed.

Once you have done the analysis with your accountant and have taken a hard look, you will be able to identify costs that are avoidable and can be pushed back. Furthermore, you will be able to see the true costs of debt and devise a plan to start saving money by repaying some of the not-so-good debt.

It is important for the survival of your business to not only look at current consumption but also reserve funds for investment in research and development. This is done to build processes that enhance and solidify your offerings and products.

Implementation of the cash management plan would need discipline and accountability. Your accountant would be invaluable in helping you devise an effective plan, and bring awareness to cash use habits and decision-making as it pertains to the future of the business. Use your accountant to make better decisions and allow them to provide oversight on how to manage cash. Your accountant is your chief value officer: they not only report on historical performance but also provide insight on how you can manage your money better in order to be sustainable and invest in the future of your business.