cash-flow
Rodolfo Basilio No Comments

You only realize the importance of understanding the real meaning of terms such as: working capital, cash flow and operating cycle, when your business is going through financial problems.

The lack of funds in your business bank account might be a problem during the business start-up, growing or declining phases.

During the start-up phase, it is clear that the business must have enough money to buy supplies and pay expenses up to a certain moment when the business starts to generate enough sales to cover all the business costs and expenses (known as break-even point).

During the growing phase, it is natural to get very excited because at this stage your business has employees, is well established for at least a couple of years, and sales grow on a monthly basis.  However, all of sudden you might realise that there is not enough money in your business bank account to pay suppliers and expenses or invest in new equipment. The lack of money could be temporary.  For a short term (a few days), medium term (a couple of months) or long term (more than one year).

If your business sales went down, it does not seem to be a temporary problem, and the actual total amount of sales generated will not be enough to cover business costs and expenses, you must prepare an emergency plan as soon as possible to try to prevent the business from accumulating losses.

Before I go into more specific details about what could be done to address all three situations described above, I would like to briefly explain to you a practical definition of the terms: working capital, cash flow and the operating cycle of a business.

Working capital is the money your business needs to be able to pay its costs and expenses. It is the amount of money your company must have available to maintain the daily operations going in order to keep it financially sustainable. It is a very important business tool for decision makers. As your company working capital increases, more financial resources must be at your disposal. In this situation, you will need to invest more of your own money in the company, otherwise, your company will need money from a third party such as a bank, finance company or investor. The working capital is obviously linked to the company operating cycle. As I explained before, sometimes, a company can have a lot of assets such as cars, equipment, and property but does not have enough cash available to pay its costs and expenses.

Cash flow is the net amount of cash coming in and out of a business. Positive cash flow indicates that the company liquid assets are increasing, which enables the company to settle any debts, makes it possible to reinvest money in the business, pay expenses and even pay dividends to the shareholders. In this way, we can say that the company is solvent.

Cash is very different from profit. Profit measures the financial performance of a business. It is basically the total sales of a company minus the total costs and expenses. The cash flow of a business is basically how much money is left at the end of a period. This is the reason we always advise our clients to measure the company profitability on a monthly basis but also prepare monthly cash flow statements. In some cases, we even advise the client to try to manage the company as the money comes in and goes out (cash flow) rather than doing it when the sales invoices are issued and purchasing orders and expenses are received.  On the other hand,  negative cash flow indicates that the company liquid assets are decreasing. In this case, it is showing that the company is not producing enough cash to cover all the business costs and expenses.

The operating cycle of a business is basically the average time required to produce products or deliver services up to when the money generated from the business sales is received.

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Your business can produce high profit margins and still suffer from lack of money in the business bank account to pay the operational costs and expenses. Several management decisions could impact the operating cycle of your business such as trade creditor and trade debtor terms. Ideally, your business needs to decrease the trade debtor term (to receive the money from the sales as soon as possible) and increase the trade creditor term (to pay the expenses and costs later).

In this way, your company will have a shorter and more favourable operating cycle. Also, the level of existing stock maintained by a company is very important and could also affect the company liquidity as stock is basically tied up money and is obviously not available money in the business bank account. The stock only becomes available in cash terms when it is sold and the money is received.

So, if your business is suffering from lack of working capital, you will find below a few solutions you could try:
Start-up phase

  • Make sure you prepare a sales forecast and costs/expenses analysis as realistic as you can
  • Make sure you also have a financial reserve for any eventuality
  • Prepare a few business scenarios (very optimistic, optimistic, pessimistic) and always use the figures from the pessimistic scenario
  • Select suppliers which are willing to give you credit and let you pay in instalments.
  • Select other suppliers which are also willing to let you pay them in instalments. (For example: Here at Vertice Services, all of our clients pay us monthly fees to help their cash flow situation.
  • Study the possibility of renting or leasing equipment rather than buying it upfront
  • Be careful with long-term contracts
  • Try to organize your business finances in such a way to receive the money from your company sales before you spend money with suppliers and other providers
  • Make sure you have a well stablished credit control system such as Direct debit and standing order
  • Control your trade creditors and trade debtors as often as you can
  • Try to reduce your company stock size
  • Find ways to reduce your delivery time
  • Having many clients is less risky than having only one

 

 

Growing phase

 

  • If your business is growing too quickly, negotiate your trade terms with your company suppliers
  • Apply for a business bank account overdraft
  • Do some research on invoice discounting. Some companies will be willing to take you as a new client
  • Improve your stock control
  • Sell any stock which has not been sold for some time for a special discounted price
  • Prepare an expenses budget and try to cut any unnecessary expenses. If cutting is not an option, please consider cutting down on them.
  • Provide clients with an incentive to receive faster
  • Offer payment terms only to clients who have a very good credit and solid payment record
  • Make sure you carry out a credit check prior to giving credit
  • Use a debt collection company if necessary
  • Employ a responsible individual to work in your financial department
  • Teach your employees upselling and cross-selling techniques
  • Accept credit cards and debit cards to speed up cash flow
  • Be aware of credit problems early
  • Carry out an analysis to find out if there is any kind of fraud happening

 

Declining Phase

 

  • Increase your sales (increase price or increase the volume of sales)
  • Find the real reason the business performance is not good enough
  • Prepare an emergency plan in which you define what actions must be taken, who will be the one responsible and set a deadline
  • Restructure your business
  • Find out if the situation is only seasonal
  • Make a full analysis of the industry your business is in
  • Act fast to prevent the situation from getting worse
  • Hire an experienced business consultant and accountant to help you
  • Take action as soon as you perceive any sign of decline
  • Don’t panic
  • If you tried everything, think about an exit strategy (e.g., sell the business, business voluntary agreement or business bankruptcy)