|Cash is Still King|
In these difficult turbulent times and being in the middle of a global credit crunch, cash flow management will play an even more critical role of being in business. A cash flow budget helps manage borrowings, collection of debtors and payment of employees, creditors and owners, as well as plan for investment spending.
Before examining the tools to help manage cash flow, we must first understand the difference between profit and loss items (such as income and expenses) and cash flows. While some expenses such as depreciation are non-cash items, the biggest single difference between profit and loss items and cash items is timing. Understanding the timing of cash flows is essential in ensuring the ongoing growth and survival of a business.
Cash in a business can get tied up in growth. Working capital is the money that allows the business to trade day to day, and it finances current assets such as stock and debtors. As a business there is often a need to finance the increased holdings of stock, as well as the increased level of debtors resulting from increased sales. The business cycle requires balance between cash receipts and payments and should be achieved by actively managing the level of cash in a business.
The tools for effective cash management include:
A workable credit policy
A credit policy helps to maintain the cash inflows in a business. It sets the terms by which the business trades with customers and properly documents the contractual relationship. It sets the expected timing for collection of the cash from sales, and enables enforcement to take place if a customer refuses to pay.
An inventory or project management system
Effective inventory and/or project management involves control of purchases and management of ongoing inventory and work-in-progress levels. It allows a business to effectively service customers and to identify and clear slow moving items. Ineffective inventory and project management can result in cash shortages and extra costs in financing WIP or holding stock.
A purchasing system
To ensure proper terms are being negotiated with suppliers and that purchases of both stock and other items are being controlled, a purchasing system should set out responsibilities and guidelines for incurring costs and debt in a business.
A cash flow budget
The overview tool that can predict cash peaks and troughs and allows a business to plan when extra finance may be needed, a cash flow budget derives from a profit and loss budget adjusted for non cash items and the difference in timing between:
The budget should always be rolled forward regularly so that the budgeting period is maintained. Timing of tax payments is a crucial element.
Remember profit and loss is an accounting concept. Cash is the real thing!
An educated financier
Maintaining a good business relationship with its financier(s) is vital to maintaining flexibility for a business' cash needs. Businesses rarely trade on the same basis month in month out, and cyclical cash needs are common. A flexible financier who is able to understand and provide for a business' cash needs on a timely basis ensures smooth cash flow management. A cash flow budget assists greatly in dealing with financiers.
Ineffective cash management can lead to an unexpected cash crisis. Financiers and suppliers are likely to be unsympathetic if poor planning means they are not getting paid on time.
Keeping a cash flow budget up to date is an integral part of being (and remaining) in business.
Our practice sees first hand how quickly things can go wrong, where there is no proper planning. Turnaround assistance has been provided to a diverse range of businesses which, whilst profitable, neglected to manage their cash flow needs. Recently an IT business sought assistance where cash flow receipts from contracts were poorly aligned to payments. Payments to suppliers on major projects were being made on 30 day terms while receipts under the contract were sometimes extended over 18 months. Simple re-negotiation of supplier terms and working capital finance averted a crisis that may have caused the demise of the business. A simple plan would have identified the need for such action well before the situation became critical.
Credit Crunch - 10 Point check
1. Cash in asap
2. Get closer to your bank
3. Be relentless on cost control
4. Revisit your strategy
5. Get smarter on tax
6. Sanity check on new investment plans
7. Keep an eye out for bargains
8. Align performance and rewards
9. Right size
10. Protect your personal wealth
For more information please consult your local Advantage One Director.