FACT: It is possible for profitable businesses to go out of business because of cash flow problems.
Sales, expenses and therefore profits, do not necessarily coincide with their associated cash receipts and payments. The result is that cash receipts can often lag cash payments and, while profits are being reported, the business may still be experiencing cash shortfalls. The sales are recorded but the cash is not in the bank yet.
Growth in a business may lead to cash shortages, because extra money is needed to finance the growth needs (extra stock, receivables or machinery). Knowing that you will have enough cash to pay a bill next month isn't enough if your creditors are pushing for payment today and you can't come up with it.
Good financial organisation, discipline, and having a plan to manage cash flow will reduce the likelihood of disruption to your business. Implementing plans for improving cash flow and using cash flow forecasts are great ways to predict and manage finances in the slower periods. Good practices for ensuring cash flow
Forecasting - knowing and planning for the peaks and troughs
- Manage the credit you offer - develop polices and procedures to ensure credit is only offered to reliable and profitable customers. Attempt to reduce the average debtors' days outstanding by e.g. specifying payment terms on your invoices, offering early payment discounts or charging interest on late accounts.
- Invoice timeously - if you don't issue an invoice, there will be no payment.
- Keep your records up to date - if your records are not kept up to date and accurate your cash flow forecast and other reports will not be accurate and the benefits of forecasting will be lost.
- Follow up customer settlements on a regular basis, not just when cash is tight.
- Plan for the unexpected - have a rainy day fund which you can borrow from at short notice for unexpected crises in cash flow. Always attempt to repay the fund when you again become flush.
- Manage your payments - don't pay early (unless a discount is offered) since that removes cash you could be using to earn interest or investing elsewhere. On the other hand don't pay late regularly since that puts suppliers offside, who might otherwise have been prepared to carry you over an emergency on the basis of your good reputation. Communicate with your suppliers timeously if you are not able to pay on time.
- Fund your business properly - capital expenditure should be matched by long-term finance so that the payments match the inflows from the investment in the asset.
- Keep stock at a minimum (this can be industry dependent): if you can reduce the amount of stock you are holding without decreasing your sales, then you have less money tied up in stock and have freed up your cash flow.
Your cash flow needs constant monitoring and planning using a cash flow forecast report to make sure you always have enough ready cash to meet your costs on time.
Profit and cash flow are two factors that do not necessarily go hand-in-hand. Businesses can fail because of cash flow issues even when they are making a profit. It is essential to manage theprocesses that determine cash flow and to forecast cash flows, in order to be aware of problems on the horizon.
Having the right procedures in place can help you manage your cash flow effectively and can mean the difference between business success and failure.
At Meredith Harington we have quite a lot of experience in this area (apart from running our own successful business for many years) and we are always willing to assist and give ideas for improvement of cash flow. Give us a go... www.meredithharington.co.za