Cashflow is one of the hardest things to manage in business. Cashflow can be tight and difficult in a business when it is growing rapidly, and also when it is suffering from low sales, or poor internal performance, or both.
So what contributes to cashflow? Your cashflow is determined by:
- your creditors (people you owe money to)
- your debtors (people that owe you money)
- inventory and stock (money spent and now sitting ‘tied up’ in a warehouse)
- prepayments (money spent ahead of time to secure a service or project, etc)
- short-term liabilities (wages, statutory payments, e.g. GST, tax, superannuation, etc).
Think of cashflow as the bloodstream in a body – if the blood flow is plentiful and the heart is pumping well, then as the body needs blood, it’s there and ready. But, if the blood is anaemic or in low supply, or the veins are constricted, then blood will not flow well, and the body will be weak.
To make sure you have a good supply of cash, make sure you have the following systems in place:
1. A clear debt collection process within your payment terms
There are 3 elements to this:
- The follow-up – ensure your finance, admin and senior team have a process for following up outstanding payments and getting to the bottom of what’s going on with a delinquent payer, and when they plan to pay.
- Debt collection – ensure your follow-up process has a threshold, beyond which you will engage an external party to help i.e. a mediator or debt collector.
- Legal process – the final element is embarking on legal proceedings to recover the debt.
Many business owners don’t like asking their clients for money, but if you get in the cycle of not chasing up clients who are outside your payment terms, the impact on your business can be severe. Don’t wait too long to rectify the payments outside terms!
2. Pre-qualify your clients and suppliers
Do your homework to ensure trading terms with both clients and suppliers are reasonably matched to your business operations.
If a client has a bad payment history, be cautious about giving them extended trading terms. Invoke ‘payment on delivery’ where necessary.
Similarly, if you are buying goods from a supplier every month, be sure their trading terms are aligned to your cashflow cycle and don’t unduly restrict your cashflow situation.
3. Optimise and minimise stock/inventory holdings
Many businesses have cash tied up in stock, sitting in a warehouse. If the stock is obsolete, slow moving, or not the latest model, then think carefully about whether you need it on the shelf, or whether you’re better to offload that stock and have the cash in your bank account, contributing to your cash buffer and cashflow.
4. Forecast
It’s important to look ahead and plan for what may be coming for your business. Forecasting requires you to consider your:
- budget
- project pipeline
- projected sales activity
- risk of downturn
- client business ‘health’
- supplier business ‘health’.
Planning ahead allows you to mitigate severe cash drains and tightness by influencing the timing of payments and purchases (e.g. negotiate favourable contracted payments associated with a project).
5. Pay your suppliers on time – not in advance
It’s important to have a good relationship with your suppliers, but that doesn’t mean you pay them in advance. Your first responsibility is to your own business, so pay suppliers in accordance with their payment terms – it is not necessary to pay earlier than the agreed payment terms.
If you do foresee a likely cashflow squeeze that may delay a payment, manage your suppliers’ expectations in advance so they understand what’s happening in your business, and provide them with a plan for how and when you will pay.
6. Ensure you operate a cash surplus/buffer or secure an overdraft limit that matches your monthly transaction requirements
It is critical that you develop a process of setting aside surplus cash or funding as a buffer for difficult periods or unforeseen circumstances, for example:
- underperforming months/quarters
- major shocks e.g. a large client goes into administration and doesn’t pay their bills
- market shocks that seriously impact trading terms
- a large unforeseen payment due to an unexpected event.
As a bare minimum, setting aside 3x your monthly operating expenses, as a buffer, is worth considering. If you can’t set aside cash, then work with your financier and identify an overdraft limit or credit facility to assist with your working capital and, therefore, your cashflow at critical times of growth or difficulty.
7. Minimise projects or activity that put your business in an unfunded position
Growth is important, but rapid growth, or growth for growth’s sake i.e. sales with low or no margin, can put the business in a very precarious position.
Gradual, incremental growth is much easier to manage than rapid growth, but sometimes it doesn’t happen that way. That’s when forecasting and having the cashflow buffer discussed above become important.
Free resources
Cashflow is key, whether your business is growing, or struggling in the market. If you would like to learn more, we have a number of free ebooks and templates to help with cashflow and general financial management:
- Cashflow management for small to mid-sized businesses
- Managing cashflow and working capital
- Tips to improve financial and operational performance
- How to give your business a strong forward outlook
- JPAbusiness Systems and Processes Checklist
And if you need support or advice regarding managing your cashflow, we’re happy to help. Contact our team by calling 02 6360 0360 or 02 9893 1803 for a confidential, obligation-free discussion.