Cash flow can be one of the toughest challenges that small business owners encounter when running their business; but focusing on cash flow management will improve your business sustainability.
Your cash flow is all about the analysis of how you manage your cash coming in and going out. In ideal situations, you want more coming in than going out, and in the perfect scenario you want your money to come in before your money goes out.
In order to achieve this perfect scenario, you will need to establish a cash flow analysis that manages your cash flow. This will allow you to ensure you have funds available when your business comes across an unexpected debt or payment. An analysis will also offer you insights to plan your cash flow cycle and avoid falling prey to ‘the cash gap’.
What is the ‘cash gap’?
The cash gap is when you buy stock from a third party supplier, you agree to pay them within 30 or 60 days, but you may not have sold the product before you need to pay your supplier; either due to mark-up challenges or because the item you bought went into the production process of another product.
The challenge comes in when your customer only pays you within 30 days of purchase. This creates the cash gap, whereby you need to pay your suppliers, but you haven’t received money from your customers yet.
The risks of not implementing proper cash flow forecasting
Here are some of the challenges you’ll come across by not implementing your cash flow forecasting correctly:
- Your business may be involuntarily pushed into taking on debt, perhaps through loans, to bridge the cash gap.
- Your business might end up owing money to multiple suppliers and creditors simultaneously.
- Your business may develop a reputation as slow payers, which could limit the amount of companies that will work with you. It may even result in suppliers charging you penalties for paying late.
- With poor cash flow management, you may not be able to pay your staff their salaries on time, which could lead to losing talented, reliable people.
- You may not be able to pay your business’ taxes on time and could find yourself penalised by SARS.
Cash flow is the lifeblood of your business. Without liquidity, you may find your hands tied when it comes to growth strategies or unexpected creditor payments. Here are a few cash flow factors that you need to be aware of to ensure the financial viability of your business:
3 Important cash flow factors
This three-point list may assist you in avoiding making the top, most common, cash flow mistakes:
1. Overestimating your future sales volumes
Unfortunately, not everyone you come into contact with will actually buy from you. While your sales may increase during certain peak retail seasons, expecting them to double is a little unrealistic.
To avoid finding yourself underwhelmed by your business’ performance you need to undertake objective and realistic sales forecasting. You’ll need to base this on historical evidence and real numbers from your business’ history. By applying quantitative forecasting methods to past revenue data from your own business, or other businesses in your industry, you’ll create a basis for tracking trends and predicting future sales.
Combine this with some objective intuition; you can develop realistic future sales projections, which will prevent you from overspending based on a pipe dream that may never come to fruition.
2. Making impulse buys
Have you started to collect purchases in your house that you look at now and think: “Why did I buy that?” Well, the same thing happens in business. The saying “It takes money to make money,” remains, arguably, a popular statement for novice entrepreneurs who fall prey to overspending. Be aware of consultants, advisors and B2B service providers that may take your capital for products or services you don’t really need.
In order for your business to make money, you’ll need to keep an eye on the bottom line. Consider the cost to benefit of every single expense, after all every cent you spend on your business is a cent you take away from your profit margin.
You can create a realistic budget with a revenue forecast. Calculate from the revenue forecast, when your business will break even. When unexpected expenses or opportunities for impulse spending arise, go back to your projection and calculate how much longer your business will take to break even. It may help you decide that your team doesn’t really need that ping pong table after all.
3. Reactively collecting customer payments
One of the more prominent challenges associated with maintaining positive cash flow, specifically in small B2B business, can come from unpaid client invoices. If you aren’t being proactive about collecting customer payments, you could be risking your cash flow situation.
If you haven’t implemented a firm late-payment penalty and collection policy, your clients may take advantage of you. If your clients know that you aren’t on top of your payment schedule, you can be sure that you’ll be their last vendor to get paid.
A good policy can include a 5% late penalty after five days, and work stoppage after 30 days past due. Create a system around how many days to wait until you send the initial invoice, when payment reminders should go out, and when you start making collection calls or cutting off services if invoices aren’t paid.
You can even benefit from incentivising customers with discounts for early payments.
You can avoid these unpleasant scenarios by implementing systems to stay on top of your finances. One of these processes that will help you better manage your business funds is creating a monthly, quarterly and annual cash flow forecast.
Creating your cash flow forecast
A cash flow forecast is valuable for any size business and perhaps even more important for small business. This is because a healthy cash flow is essential for small businesses, as large amounts of capital are not usually available in case of emergency.
Forecasting can assist your business with:
- Planning exactly how much you expect to make in sales over a specific time period.
- Planning exactly how much you expect to spend in costs over that same time period.
- Understanding when cash will come and go from your bank account.
Empowered with this knowledge, you can now make conclusive decisions about your business and plan for its future.
How you can prepare a cash flow forecast
Standard Bank’s business experts recommend that you should do daily, weekly and monthly cash flow forecasts to enable you to make sound financial decisions. Your analysis should keep track of when you expect payment from customers, as well as when you intend to pay your suppliers.
An adequately constructed cash flow forecast will help you clearly identify potential ‘cash gaps’, which will strategically assist you in avoiding a difficult situation. If you can see when you need money from your debtors, you can push for payment or if you need to you can negotiate with your creditors for delayed payment terms.
A cash flow forecast allows you to link your sales strategy into your cash flow cycle. This enables you to bridge the gap between sales and funding, when your business is experiencing a lull in income. Organising your cash flow into a spreadsheet can help you to proactively plan your way out of a restrictive cash flow situation.
Here is a 7-point list on how to prepare a cash flow forecast:
- On your spreadsheet, you will need to enter the amount of cash you currently have at the beginning of the time period that you’re going to be forecasting for.
- Add to your spreadsheet, your cash inflows that you’re expecting to collect during this period, such as customer payments, interest earnings and dividends.
- The inflow of cash your business experiences will rely on the method of payment that your clients will use, for example cash, or credit. You can include the cash sales immediately into your spreadsheet and you can enter the credit sales when you expect your customers to pay. The income from your credit sales will depend on your credit management policy, and how efficiently you can control and collect these payments from your customers.
- Inform your customers specifically when their payments are due for collection. During the collection process, remember to take into account your customers’ previous payment history and the economic outlook.
- Strategically schedule the timing of your business expense payments. It is important that you are as specific as you can be about the amount and month that each expense is due.
- Add cash outflows from the items you’ve listed in your expenses forecast, including payments to suppliers and credit cards, loan repayments and taxes.
- Include in your spreadsheet, regular, irregular and seasonal payments, including rent, repairs, and maintenance and inventory purchases.
How to improve your cash management
The experts from Standard Bank’s Small Enterprise and Enterprise Development department say that one of the biggest challenges facing SMEs is cash flow. No matter how much you know about what your customers’ want, the art of managing money and ensuring that cash is available to purchase stock and pay business expenses and salaries is essential to success. The quicker you master this art, the quicker the business will prosper and grow.
“The challenge of achieving a balance between cash-in and cash-out can be especially difficult to manage if you need to purchase stock and hold onto it before selling it,” according to the experts at Standard Bank’s Small Enterprise and Enterprise Development department. A good example of this is the clothing industry, where you would purchase clothing one season, ahead of actual sales activity.
You can improve your cash flow by following a well thought-out plan that will assist you in avoiding stressful business debts. Consider the following and how you can put it in place:
- Ensure that your customers want your product or service, rather than creating something that you like. Your stock needs to sell as quickly as possible to infuse cash back into your business, and for your business to grow and develop.
During the course of running and growing your business, you will need access to both short-term and long-term cash savings to pay salaries, suppliers, or even to save for a future project or large payment. Standard Bank provides a range of flexible Savings and Investment solutions, with competitive interest rates, to help you meet your business’s savings and investment needs.
Deciding on products from your personal preference could cause items to stay on the shelves longer than expected. This is an example of an investment that isn’t benefiting your business. Ultimately, slow sales can cause cash flow problems as well.
6 Steps to achieving positive cash flow in your business
“The aim is to ensure that more money is coming in than is flowing out, so that you achieve a positive cash flow balance. Getting to this ideal state is possible if you take the correct steps,” explains Standard Bank’s experts.
These steps should encompass:
Step 1: Working with a realistic budget. A realistic budget will help to keep your cash flow on track and ensure that you limit spending.
Step 2: You should constantly review your costs. You can reduce costs by making early payments to suppliers who offer discounts.
Step 3: Use a lean approach. Hold on to capital by ensuring you have just enough stock for your purposes. The larger your inventory, the longer it will take to sell; and the longer you have unusable capital sitting in your warehouse.
Step 4: Pay employees first, and then critical suppliers. Don’t just focus on small invoices.
Step 5: Ask for deposits when your customers order goods, you can put this payment to good use while you’re still filling the order.
Step 6: Be on the ball with your invoicing. Send invoices out as soon as you’ve completed the job and not at the end of the month.
Fitting cash flow into the big picture of running your business
There is one cardinal rule to keeping a business successfully up and running; don’t run out of cash. To control the amount of cash your business has, you must properly manage your cash inflows and outflows. A cash flow statement allows you to get a handle on your cash flow, by providing you with the information you need. You can better manage your cash flow by:
- Keeping your cash flow forecasts prepared and maintained. This can become an informative schedule showing you an estimate of future funds coming in and out over a period of at least a year.
- Setting cash flow targets enables you to set goals for your credit controllers. This will ensure organisation and timeliness of credit payments.
- Monitor your numbers closely to ensure you’re on top of your sales and expenses. You should also monitor your business banking account, accounts receivable and accounts payable each week, to ensure your business is moving in the right direction.
- Improve the speed of your receivables by optimising the process of turning materials into products, inventory into receivables and receivables into cash.
5 Simple-to-use techniques to increase your cash flow
Your business will not only need a healthy cash flow, it needs cash flow that develops growth. Here are five top tips to assist you in increasing your cash flow:
- Increase sales, by attracting new customers or selling additional goods and services to existing customers. Manage your stock better and keep track of daily sales and ensure your inventory matches with the sales numbers.
- Reduce your cost of sale as much as you can, this will increase your gross profit per product.
- Keep your business running lean, with low monthly expenses. This will improve your net profit margin.
- Let your suppliers know about your financial situation. This will work in your favour if you have to delay a payment, as they will trust and understand your situation.
- If you can, pay on-time to secure discounts for early payments.
2 Important processing methods to improve your cash flow
Now that you know how to manage your cash flow and how to increase your cash flow, here are two methods that will assist you in managing your cash flow more effectively:
Method 1: Use technology to manage your cash flow
Accounting software can help you to simplify your cash flow management by assisting you in monitoring your inflows and outflows at a glance. You can view financial dashboards and reports, tracking when receivables and payables are due.
Method 2: Assign someone to manage your cash flow
You can train a dedicated person to track when and where the money is going in and out. Your designated cash flow employee can keep a close eye on your daily credits and debits to ensure there is always sufficient cash in your business.
Planning for potential cash flow hazards
Keeping track of exactly how much money your business has and how much it owes may sound simple, but it often isn’t. Cash flow management will assist you in ensuring that you have more money in your business than you need to pay out, which is essential to your business’ ongoing success.
Standard Bank’s expert’s advice that when it comes to ensuring positive cash flow within your business you should aim to implement systems and processes for better flow of cash. These four steps may assist you in improving your cash flow situation:
1. Getting the balance right between cash inflows and outflows.
You can achieve this by:
- Reducing the sales cycle time to generate cash quickly, but only after examining suppliers’ and customers’ credit terms.
- Using point of sale machines and accounting systems designed for SMEs, such as those offered through Standard Bank’s BizLaunch, to process transactions quickly.
2. Manage pricing so that at the end of the day you make a profit.
Consider not discounting your products as this reduces your profits.
3. Manage your creditors by:
- Negotiating for a 60- or 90-day payment term with your suppliers
- Increasing credit limits to receive more stock
- Push for discounts from suppliers when making bulk purchases and early payments.
4. Control expenses by:
- Reducing costs
- Consolidating loans
- Comparing leasing and financing options and costs, and selling off superfluous items
- Selling off redundant stock, even at cost, to get cash back into your business.
“The skills required to manage cash flow can become a positive habit if you use them often. Skills can help build your business for the future,” revels experts at Standard Bank.
When money isn’t flowing in and out as expected
Here are some techniques for when you find yourself in-between a rock and a hard place:
Technique 1: When you’re short on cash
There may come a time in your business, when you face a sudden shortage of cash to pay your expenses. This doesn’t mean you’ve failed, it means you’re an entrepreneur who, despite your best efforts, can’t always predict the future and what the market will do.
Solution:There are a number of business practices that can help you to manage a cash shortfall. Becoming aware of cash shortfalls, as early and as accurately as you can remains important. Banks prefer to lend money months before you actually need it, as it indicates that you are aware of what is happening within your business and that you can predict financial gaps, which makes you less risky.
Technique 2: Arranging lines of credit
There are numerous ways to arrange a line of credit if you can forecast a cash flow problem. The first is through your bank. If you assume, from the beginning, that someday you might need access to credit, arrange a line of credit early, while your books still look good.
You can also negotiate with your suppliers; do this earlier rather than later. The health and success of your business impacts that of your supplier and they have a keen interest in keeping you going. If you’ve built a rapport with your suppliers and always kept them informed about your financial situation, you have a greater chance ofcoming to a payment agreement that’s mutually beneficial.
Factoring is the process where companies sell their debtor’s book to a bank, which then forwards cash against that debtor's book. It is predominantly a tool for businesses experiencing growth, and is on a full disclosure basis, where debtors are aware of the factoring services.
Technique 3: Discounting
This is done on a confidential basis, where the debtor is not made aware of the involvement of the factoring house or bank, and the client continues to administer its own debtors.
Ask your best customers to pay you earlier. If necessary, you’ll need to explain the situation, and you could even offer them a discount if it convinces them to pay sooner. Determine who your worst customers are (more than 90 days past due) and offer them harsher penalties if they can’t make immediate payment.
Sell and lease back
Another means of raising cash is by selling and leasing back your equipment. This can include machinery, computers, telecoms systems and furniture.
Cash flow is the lifeblood of your business, without liquidity you might find your hands tied when it comes to growth strategies or unexpected creditor payments. The lessons encompassed in this comprehensive cash flow management guide can assist you in building a thriving business.