How To Successfully Manage Your Cash Flow

How does your cash flow? Why is cash flow so important to smaller medium-sized private businesses? And what are some common distress signs of a business going through a cash flow crunch?

Managing your cash flow may seem daunting – but, equipped with the right tools, it doesn’t have to be.

Here, we look at strategies, including working capital, to help your business improve its cash flow.

Why is cash flow important?

Businesses can be profitable but still fail. And on the flipside, businesses can be unprofitable and remain solvent for a period of time (but they won’t last forever).

In many respects, cash flow is more important than profitability. While the two go hand-in-hand, the speed at which money comes in and out of your business can be the difference between whether or not it can stay afloat.

There are two main and straightforward strategies to improving your cash flow – improve your money inflows, and reduce your money outflows. A “cash flow crisis” will often be the result of either a shock to the business such as a weather event (cyclone/hail storm/flood) or a large debtor failing to pay.

However cash flow crises can also be the result of something more systemic within the business and will generally last a lot longer and can be more difficult to manage. This includes times where profitability of a produce line falls for a sustained period, or a major input cost (i.e. labour) steadily increases with no reciprocal increase in the revenue of the produce being sold.

Signs of cash flow problems

These are some of the signs a business is struggling with poor cash flow:

• You have large ATO debts that are unpaid and overdue.
• You haven’t paid employees’ Super Guarantee Charge (SGC). Aside from the obvious moral issues with this, failing to pay employer super as a strategy to manage your cash flow puts you at risk of director liabilities and personal liabilities.
• You have multiple credit card facilities maxed out. This is also likely not the most efficient source of financing.
• You have creditors out on extended terms.

Tools to manage your cash flow

Unless you are a start-up, your business should be aiming to be profitable. Developing a budget will help you determine whether a profit is likely to be achieved and at what point the business is breaking even.

Start by developing a budget and a break-even point analysis. Work out what your business’ fixed costs are, and an indication of what you can sell your product for, to calculate how much product you need to sell to reach break-even point.

Budgets are also a great tool to manage cash flow. For those of you in primary industries, you might set a budget and then experience a major weather event, changing the situation entirely – but we still recommend you do it.

Unless something has significantly changed in your business, last year’s actuals can be a good starting point. Tweak the budget on a monthly basis according to how your business is going.

Tip: Don’t prepare your budget with rose-coloured glasses. As we all know, a good season is just a rainfall event away, just as much as a bad season is only one hail storm or drought event away. Shoot for what’s realistic, and anything beyond that is a bonus.

We recommend developing three budgets being a ‘base case’ – which is the status quo of the business and then developing ‘good season’ and ‘poor season’ budgets from the base case. Having the three scenarios in separate budgets allows you as business owner/manager to begin to strategise how to manage cash flow as the season unfolds and if a weather event occurs you are financial prepared to manage the situation.

A more advanced form of budgeting is what’s known as ‘3-way forecasting’ which essentially involves budgeting not just for cash flow, but for profitability and equity of the business. This is done in the form of the following:

• balance sheet
• profit and loss
• cash flow statement.

This gives a snapshot of a business’ performance and position as a result of an expected set of events (e.g. lower sales volume, but higher margin). Banks are increasingly looking for this type of modelling as it can show that short term cash restrictions might simply be the result of higher levels of inventory or slower paying customers.

Working capital

Understanding working capital is also critical to good cash flow management. It refers to the money needed to fund the normal, day-to-day operations of a business.

Working capital is effectively made up of: Stock on Hand + Debtors – Creditors.

Too little working capital can be detrimental to a business because you don’t have enough to satisfy your creditors, likely indicating the business will grind to a halt relatively quickly. Similarly, too much working capital could mean that the business is not using cash effectively – operating on what’s called a ‘lazy balance sheet’.

A working capital ratio is your current assets over your current liabilities, the assets you can realize within a 12-month period and your liabilities that need to be paid within a 12-month period.

Divide your current assets by your current liabilities to get your working capital ratio. In the finance world, a figure of between 1.2 – 2 times is considered a strong or reasonable working capital ratio. If your ratio is greater than two, that indicates a very solvent business. It might also, however, indicate there’s too much cash or stock potentially being used inefficiently.

Equally, if your ratio is below 1.2, it may be a short-term timing reason. If it’s regularly below 1.2, the business is likely suffering from a systemic cash flow problem which should be addressed as soon as possible.

Other tips to improve cash flow

Improving cash flow is the result of either increasing cash inflows or reducing cash outflows. While most horticultural producers have little bargaining power regarding sales prices (and therefore cash inflows) here are some final common tools you may be able to enact in your business.

1. Where product is forward commuted to a customer, charge a deposit before starting the work to help cover some of the initial costs of completing the job.
2. Offer discounts on early payment/upfront payment.
3. Invoice throughout the job (don’t just wait until the end).
4. Charge ‘administration fees’ to customers who continually pay late.
5. Be proactive in collecting your debtors. Most customers don’t like receiving phone calls asking them to pay overdue invoices.
6. Negotiate trade terms with suppliers.
7. Take advantage of deferrals (i.e. BAS extensions & ATO payment plans). But be aware of the terms of these options and the ramifications of defaults.

These strategies are just some of the ways to help get your business’ cash flow on track for success.

Want to know more about how Bentleys can help you?

Make a time for a chat with us today. We’re here to help you get where you want to be.

Disclaimer: This information is general in nature and should not be relied on as advice. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs and seek professional advice before making any decisions based on this information.