|Going Broke Profitably|
The difference between cash flow and a so-called accounting profit is on a par with the difference between chalk and cheese. Maintain mastery of cash flow management and you'll never go broke. On the other hand, assume your business will be able to turn into cash what the books say is your due, and you're making an assumption so rash it could well send you broke.
For a start, you can't assume debtors will pay you on time, indeed that they'll ever pay you. Their problems can be the genesis of your downfall.
As a priority therefore, your cash flow strategy should be designed from the start to rely as little as possible on the reliability of others.
Conventional wisdom has it that the basis of good cash flow management is all about establishing systems that will maximise chances of being paid by the greatest possible number of debtors on, or as close as possible to, the due date.
Tradition also has it that concurrently you should keep a tight control of inventory, and delay paying creditors as long as you can without either devaluing your credit rating or your relationship with important suppliers.
However, some advisers are now saying that cash management that doesn't take account of a business's organisational process as a whole can't be effective management.
For example, by reducing production line ineptitude, not only could more units be produced in less time using less material, but also of a quality certain to lessen returns and the number of disputed, unpaid invoices. In just this one area of the business, aids to cash flow could have been achieved, multiplied one upon another.
However, any unilateral decision to reduce inventory, while it might seem to increase cash flow, might well be counter productive for the organisation as a whole, because a more efficient production line could result in bigger orders which couldn't be filled from a depleted inventory.
It's been argued that to get a proper appreciation of a cash flow situation at any given time, the Debtor Days need to be tracked in conjunction with days in inventory or days in creditors. But however you decide you want to manage cash flow for your business, there's no doubt organisations can get a better flow of money simply by improving dispute resolution procedures.
The longer a customer disputes an amount charged on an invoice, the longer the quality of a product or service is disputed by a client, the longer payment is delayed and the greater the disruption to your cash flow.
A readily operated system for dispute resolution is therefore a most useful element in a holistic cash flow management strategy. If a customer claims to have been overcharged on an item, have a system in place for resolving the matter quickly, and if it's resolved in the customer's favour, for issuing a credit note immediately. Don't delay settlement of a statement because of quibbling about one item.
And remember a gram of prevention is worth a tonne of cure. Thus, at the best of times, a cash flow system should be operating like well-maintained machinery - for in the face of a crisis you don't want suddenly to have to divert resources that could perhaps overcome the problem, to instead investigating a suspect cash flow budget. You should be able to look at a viable budget for a cash flow forecast three months in advance and this should be linked to forecasts for both the profit and loss statement and balance sheet. (running an organisation that has a cash flow forecast not hooked up to P&L and BS forecasts is about as safe as trying to ride a racehorse without a bridle and bit.)
Whatever you think of the GST, its positive aspects include compelling businesses to improve reporting systems, which increases reliability of records, which makes cash flow planning more effective. Combine this with ever-increasing competition, shrinking profit margins and despite the strength of the economy, a lurking threat of further interest rate rises, and you have circumstances where the quality of cash flow management could be the difference between life and death for many a business.
Managers should resist the temptation to establish a cash flow plan using short-term finance (like overdrafts) for long-term investments (like business assets). It can be sensible to use short-term finance for financing working capital expenditure (buying stock and covering expenses involved in selling and shipping it while waiting for an invoice to be paid), but long-term investments (land and buildings) should be financed if need be, through long-term debt - horses for courses!
If you're starting a business, beware of over-optimism. When presenting your business plan to a financier, avoid incorporating in it, a cash flow forecast that's far too optimistic. You may get the start-up money, but then feel you need more, and in asking, strike insurmountable resistance from the financier who says:
"I can see it's a paper profit, but your actually going broke!"
Tony Martin - Director Advantage One
Strategic Financial Coach