The cash flow is the lifeblood of your business. Poorly managed, it can start to hurt the profitability and stability of your business, and as such it’s important to keep close track of and control over the way that cash moves through the business.

There’s a popular saying that 60% of businesses that go bust are still profitable, but run out of cash. This statistic is not necessarily accurate, but the underlying message is sound: it is entirely possible, if not likely, that a highly profitable business with poor cash flow management will run out of cash and be driven into liquidation as a consequence.

First steps to good cash flow

The first goal of any business should be to understand whether its cash flow is in a safe, sustainable position, and if it is able to stay on top of expenses while also ensuring that enough cash is coming in to cover the inevitable new expenses.

There is a five-step checklist that organisations should go through (and regularly keep an eye on) in order to keep an eye on their cash flow, and be able to tell well in advance if there is a problem on the horizon that needs to be dealt with before it becomes critical.

  1. Understand the amount of working capital the business needs to operate
    This simply means that you should keep track of the invoicing which comes in from suppliers, to understand the amount of cash that you will be required to pay through on a monthly basis. One of the things that can hurt a business the most is having invoices left unpaid over extended periods of time, as they can easily start to create an avalanche of expenses when those owed the money begin insisting on it being paid in full.
  2. Do you have enough working capital?
    Once you understand the working capital of a business, the next step is to ensure that there is enough cash available to fund it. Traditionally you’d want to have enough cash available in the company bank accounts to cover all expenses for three months, assuming no additional revenue was brought into the business. Most modern businesses can’t operate with that much of a buffer, so instead it’s important that you’ve got enough personal funds available or an overdraft or revolving credit facility in the event of an emergency.
  3. Plan ahead
    The next step is to accurately forecast ahead. Businesses in every industry have down periods, and it’s important to take those periods where less revenue is coming into the business into account when looking at the cash available to the business.
  4. Understand the systems behind your business’ revenue 
    If you invoice on a single date each month and customers are required to pay within a month of that, your business might not receive its income until as much as two months after completing the project (and that’s only if they all pay on time). If, however, you invoice on the completion of projects, you can’t expect a single large injection of cash into the business at any single point in time. Understanding how your business earns money will also help you understand how it will pay its own bills, both large and small.
  5. Try to keep cash conversion cycles down 
    Businesses often work on 180 day cycles, but that can be too long to keep a healthy cash flow in the modern business environment. Cash flow works better when customers pay on a regular basis, so the well-run businesses are trying to sign their customers up on a subscription or retainer basis, or at least mandating a deposit for work signed. This also helps businesses that hold inventory to keep the inventory levels down, with inventory being one of the most negative impacts on healthy cash flow for organisations (after all, inventory is something that has been paid for that isn’t earning revenue).

A guide to improving cash flow

The best place to start with building a better cash flow through your business is by making sure you’ve got a good accountant. This is especially important for the smaller businesses, who often try and operate without one.

A good accountant will help you develop a responsible and accurate cash flow forecast, and will be able to proactively monitor the cash flow through the business to check for irregularities. And if you have late-paying customers, they can follow up with them on your behalf. Research has shown that those SMEs with an advisory relationship with their accountant are 31% more likely to see improved earnings, and so while an accountant can be an additional cost on the business (especially if they are expected to also behave in an advisory role), it’s a cost that is ultimately returned into the business.

There are other things that a business can do for themselves though, to help keep a steady cash flow through the organisation.

  • Build a good relationship with your creditors, by making payments on time as often as possible. That way, if the business does experience a period of cash shortfall, the creditors are more likely to be comfortable with extending credit terms.
  • Manage the stock. If your inventory does include items that are not selling well, get rid of them as quickly as possible via steep discounts or the like. Inventory is locked away cash, and the fundamental reason that you’ll see retailers discount items once they’ve gone out of season is to churn out inventory and free up that cash, even if it’s not at full value. Businesses in other industries should be thinking down the same lines.

There are also a number of approaches that you should make with people that owe you money (your debtors), in order to improve the flow of money into your business.

  • Establish terms up-front. Your customer should know, before any work is done for them or they take possession of the goods, when they payment is due. The invoice should reflect this clearly, and should clearly state the bank account information that the payment should be made into. Ideally, to keep the cash flow speedy, make all accounts payable within 14 days.
  • For large invoices, allow the customer to pay in instalments over a period of time. This will guarantee you cash at regular intervals, and will help ensure that your invoice doesn’t get left for a time “when we can pay it.”
  • Consider offering an online payment portal, if you don’t already. An invoice that you drop in someone’s inbox is one they can subsequently ignore until it is convenient for them. Having online payment, however, allows you to obtain the cash instantly, significantly speeding up your cash flow.
  • If the customer should default on the payment, continue to offer ways for them to reimburse you. You might want to consider bringing on a debt collection agency to help here, but ensure that you are using a reputable one. This will save your business from any potential reputational damage from working with an overzealous or unethical debt collection company.

Financing your working capital

As nice as it would be to be able to rely entirely on revenue and profit to finance your organisation’s cash flow, that is often impractical, and it’s important to have additional lines of finance to help keep the cash flow through the organisation steady. In addition to business revenue and profit, there are four other main sources of finance that many businesses will use to boost their cash flow when necessary.

  • Credit card 
    Best used in emergencies only, credit cards are nonetheless a useful source of instant cash. Ideally, as with personal credit cards, you want to pay the balance off in full each month. Otherwise fees and interest rates will make the cash flow worse in the long run.
  • Bank overdraft
    A bank overdraft is also useful in the short term, as it is both flexible and easy to work with, but interest rates do tend to be higher than you would see in a normal bank loan. So for this reason, bank overdrafts are not as useful for long-term cash flow solutions as bank loans.
  • Bank loan 
    Being locked into repayments over a long period of time can be a pain to deal with, but the relatively low interest rates that are provided by bank loans make them one of the most effective sources of cash for a business. Just be aware that in the event of a default, a business bank loan will likely be secured against your businesses’ assets, which will then be put at risk.
  • Leasing/sale and lease-back
    Leasing allows for the purchase of new equipment or assets without upfront costs, and offers numerous tax advantages. One effective way to get up-front cash is to sell an asset (typically property or vehicles), and then lease it back over a period of time. Again, this locks you into a long period of repayments, and there will generally be penalties to cancel the arrangement early.
  • One final note
    It will often be tempting to involve your personal finances with your business, but it is strongly recommended that you do not do this. While your personal finance might improve your business’ cash flow, it also exposes your personal credit rating to risk should the business continue to struggle.

More information? To find out more, give us a call on 1300 023 782 or email team@cdrta.com.au.

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Craig is the principal consultant of C&D Restructure and Taxation Advisory and has been working in the industry since 1999. Having established C&D Commercial Partners in 2015 the precursor to the current business.

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Post Author: Craig Dangar

Craig is the principal consultant of C&D Restructure and Taxation Advisory and has been working in the industry since 1999. Having established C&D Commercial Partners in 2015 the precursor to the current business.

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