Financial Data
Updated 22 Feb 2020


Cash flow management

Projecting cash flow, cash cycle analysis and surviving shortfalls.


Projecting cash flow

The definition of cash flow management

Effective financial management is essential to a growing company – particularly cash flow. The lag between paying your suppliers and employees and collecting from your customers can mean the difference between a well managed business and a poorly performing one.

In simple terms, cash flow management allows you to delay outlays of cash as long as possible (accounts payable), while encouraging the collection of money owed you (accounts receivable) to be paid as soon as possible.

Measuring cash flow

Cash flow plans are not a glimpse into the future. They are however an educated guess, based on a number of factors, that allow you to prepare your cash flow projections.

These factors include your customers’ payment histories, your own thoroughness at identifying upcoming expenditures and the policies of your vendors and the terms you have negotiated with them.

You also cannot assume that all these factors are constant. Receivables might not continue coming in at the same rate, you might not be able to extend payables as you have in the past and expenses may increase, particularly through seasonal sale fluctuations, exchange rates and inflation.

Cash flow projections

Step 1: Calculate cash on hand

A cash flow projection starts by adding cash on hand at the beginning of a period to cash received from other sources. Gather information from service representatives, sales people, credit workers, collections and your finance department.

Ask how much cash is expected to be collected in the form of:

  • Customer payments
  • Service fees
  • Interest earnings
  • Partial collections of bad debts
  • Other sources
  • Make sure you understand what’s coming in, and when it’s coming in.

Avoid mistakes: Don’t treat sales as revenue until you’ve invoiced

Don’t count deposits as income. Depending on what you do, it could take months before the service is rendered or the equipment installed, delivered etc. If you post great sales this month, when the revenue will only come in later, you can give your business a false sense of profitably – and incorrectly predict cash flow.

Step 2: Ensure a detailed knowledge of amounts and dates of upcoming cash outlays

This means not only knowing when each rand will be spent, but what it will be spent on. You should have a line item on your projection for every significant outlay of cash, including:

  • Rent
  • Inventory (when purchased for cash)
  • Salaries and wages
  • Sales
  • Taxes withheld or payable
  • Benefits paid
  • Equipment purchased (when purchased for cash)
  • Professional fees
  • Utilities
  • Office supplies
  • Debt payments
  • Advertising
  • Vehicle and equipment maintenance
  • Fuel
  • Cash dividends

As difficult as it is to prepare projections, this is one of the most important elements in cash flow management and planning for the future.

Cash Cycle Analysis

The Cash Cycle

The use of cash in the day-to-day operations of a business is called a cash cycle. A cash cycle analysis looks at how cash is unnecessarily locked up in the daily workings of the business. There are three areas where cash could be trapped and therefore unavailable to the business.

  • Accounts receivable

This is what customers owe for what they’ve bought on credit. This is money that essentially ‘belongs’ to your business, but is not yet in the bank, and is therefore currently inaccessible for use in the daily operations of the business.

  • Inventory

This includes materials, work-in-progress or finished goods that have not yet been invoiced.

  • Accounts payable

This is what you owe to your suppliers for goods and services that you have bought on credit. You can release extra cash into your business if you fully utilise the credit your supplier gives you. Always negotiate the best terms possible.

A cash cycle analysis carefully analyses the amount of cash locked up in each of these three elements of business. It then works to unlock this cash, which results in healthy cash flow management.

Performing a cash cycle analysis

Step 1: Calculate the cash days in a cash cycle

First, you need to understand how many days’ worth of cash are locked up in each of the three elements of a cash cycle.

Accounts receivable:Cash days are calculated as the accounts receivable balance divided by the average sales per day.

Inventory:Cash days are calculated as the inventory balance, divided by the average daily cost of sales.

Accounts payable:Cash days are the accounts payable divided by the average daily cost of sales.

Total cash days are the sum of all three, accounts receivable + inventory + accounts payable.

Step 2: Are the number of days in each cash cycle reasonable?

It is reasonable for all businesses to have some cash tied up in the cash cycle. The key to effective financial management however is to reduce the overall days tied up in the cash cycle to a competitive level.

To have more cash available to grow your business, you need to reduce the number of days in accounts receivable and inventory, and increase the number of days in accounts payable. These all need to be done in a reasonable and sensible way.

Once you have calculated the number of days in each element of the cash cycle (see step one), you then need to assess your business days in each element. This is done in relation to three key things:

  • The number of days in prior periods. This is so that you can evaluate if cash management is improving or declining.
  • How the number of days compare to the firm’s policy (you should have policies relating to accounts receivable and inventory, as well as your suppliers’ policies for accounts payable). By comparing days to firm policies, you can assess whether policies are being implemented.
  • The number of days of other businesses operating within your industry. This will allow you to evaluate your competitiveness compared to other firms. You can usually find this information in one of the following ways:
  • The simplest way to find financial information on other firms is to look at the financial statements listed on the JSE or AltX exchange.
  • The company website often lists this information under an investor relations section.
  • The Moneyweb website (www.moneyweb.co.za) has a “CLICK-A-COMPANY” tab where you can choose a company you are interested in to access any SENS announcements the company has made. From these you can gather the information needed to calculate accounts receivable days, inventory and accounts payable days.

This is not an analysis that can be achieved overnight. You need to compare the days in each element of a cash cycle over time to be able to determine whether you have been more or less effective in managing your cash.

Step 3: Setting targets for managing the elements of your cash cycle

You will more than likely have discovered through the previous two steps that there is room for improvement within the three elements of your cash cycle, and that there is cash tied up in accounts receivable, accounts payable, inventory or all three.

You now need to set targets to improve these balances. These targets should be reasonable within your industry. They should also be ambitious, but not so unreasonable that your business cannot operate effectively. For example, if the industry norm is for customers to pay invoices on 30 days, don’t set a target of 15 days.

Similarly, don’t let your service levels drop because you don’t have enough inventory on hand because you have drastically reduced your inventory days. Don’t pay accounts payable on 50 days if your supplier’s policy is 30 days either. Negotiate the best possible deal, but don’t develop poor relations with your supplier.

Step 4: Managing your cash cycle

Once you’ve established your actual cash days and set targets for improvement, you now need to manage your balances to reach those targets. The core idea is to improve how quickly you turn materials into products, inventory into receivables, and finally receivables into cash.

Improving receivables:

  • Issue invoices promptly and efficiently (eg email versus the post office).
  • Incentivise your accounts department to get invoices out as soon as possible, and then have weekly or biweekly meetings to track the progress of collections and follow up on slow payments.
  • Adjust your credit policy to reduce the number of credit days allowed to customers. However, you should only do this if it will not negatively affect your sales.
  • Actively follow up with customers. Make it as simple for them to pay you as possible, and remain top of mind.
  • Incentivise customers to pay early through discounts and rewards.
  • Ask for deposits when orders are made.
  • Do credit checks on new customers who are not paying upfront cash.
  • Pay attention to old, outdated inventory and get rid of it for whatever you can get.
  • Track accounts receivables to identify slow-paying customers. You can then make a policy of cash on delivery for these customers, or perhaps incentivise quicker payments.

Avoid mistakes: Don’t confuse cash flow with profits

If you are showing a profit on paper, but don’t seem to have any cash left at the end of the month, it might be because you are spending money faster than you are making it. Slow spending on new products, equipment, growth etc and focus on getting your invoices paid. Always track what you are spending, versus what you are selling – and cash in the bank.

Manage inventory levels downward:

  • Understand your inventory. Identify what you need regularly and what you need less regularly, and manage accordingly. Don’t have more inventory than you need.
  • Keep smaller amounts of stock on hand. Set up relationships with suppliers who can supply goods more regularly in smaller batches.
  • Identify slow moving and obsolete stock and provide incentives to move it off the floor.

Managing payables:

  • It’s important to note that top-line sales growth can conceal problems. Particularly when you are growing a business, keep a careful eye on expenses. Expanding sales doesn’t mean a bigger profit if your expenses are growing faster than your sales. Examine costs carefully to be able to cut or control them.
  • Always take full advantage of creditor payment terms, unless you are incentivised to do otherwise. If a payment is due in 45 days, don’t pay it in 25.
  • Make use of EFTs (electronic funds transfers). This will allow you to make your payments on time, while keeping cash in the bank for as long as possible.
  • Always communicate with your suppliers. If they understand your financial situation, they might be inclined to help – especially if you are a good client who has always been reliable. This could include allowing you to delay payments. It’s all about trust and understanding.
  • Consider discounts for earlier payments. These could either reduce your overall costs, or amount to expensive loans for your vendors. Understand all the implications of any offer/deal.
  • Choosing suppliers isn’t always about price. More flexible payment terms might improve your cash flow more than the lowest price on offer.

Note that this is not a quick fix. If your targets are reasonable and you implement your tactics in a reasonable way, over time you will reduce the amount of cash tied up in your business’s cash cycle.

Avoid mistakes: Consider how a large purchase will impact your cash

Before you make your next big purchase – even if it’s for growth purposes – evaluate how the equipment will depreciate over time, and if your cash reserves can handle the purchase. Instead, consider a short-term loan if the purchase will put a serious dent in your reserves. Be aware of the interest rates and evaluate your best options. Also ensure that the expense is worth the increased revenue.

Step 5: Review your progress

Your cash cycle needs to be constantly reviewed and managed. Both accounts receivable and inventory balances can creep up on you if unchecked, sucking cash out of the business.

In fact, cash cycle numbers, which include accounts receivable, inventory days and accounts payable days, should all become a part of the business’s monthly management dashboard. If you are constantly reviewing these numbers, you will be able to immediately investigate and take action if they are moving in the wrong direction.

Surviving Shortfalls

Lacking cash

At one point or another, many business owners face a situation where they lack the cash to pay their bills. This does not mean you are a failure – it simply means you are a normal entrepreneur who, despite best efforts, can’t always predict the future and what the market will do.

The good news is that there are a number of business practices that can help you manage a shortfall. The important thing is to become aware of the shortfall as early and as accurately as possible. Banks would prefer to lend to you months before you need the money – it shows you are aware of what is happening within your business, and you can predict the gaps.

This makes you less of a risk than a business owner who doesn’t see a problem until they are in it – and need the money today. Banks want to be able to see that you can plan ahead.

Arranging lines of credit

  • Banks.There are a number of ways to arrange a line of credit if you predict cash flow problems. 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 things are good. Arranging a line of credit before you are short is vital.
  • Suppliers.You can also negotiate with your suppliers. Again, this is better done earlier rather than later. The health and success of your business impacts that of your supplier – they have a keen interest in keeping you going, and they probably understand your business well. You might get extended credit terms (which is essentially the same as a loan) simply by asking. If you’ve been a good customer in the past and always kept your supplier informed about your financial situation, you have even more of a chance of working something out.
  • Factoring.Factoring is the process whereby 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 done on a full disclosure basis, whereby debtors are made aware of the factoring services that are being employed.

Invoice Discounting, unlike factoring, is done on a confidential basis whereby the debtor is not made aware of the involvement of the factoring house or bank, and the client continues to administer its own debtors.

  • Invoice discounting.Unlike factoring, invoice discounting is done on a confidential basis whereby the debtor is not made aware of the involvement of the factoring house or bank, and the client continues to administer its own debtors.
  • Customers.Ask your best customers to pay you earlier. If necessary, explain the situation, and even offer a discount if it helps them to pay sooner. Determine who your worst customers are (more than 90 days past due) and offer them steeper discounts for immediate payments.
  • Sell and lease back.Another means of raising cash is by selling and leasing back equipment in your business. This includes machinery, computers, telecoms systems and furniture.
  • Pay carefully.Choose which bills to pay carefully. Don’t just focus on the smaller invoices. Make payroll first – don’t lose your employees - and then pay crucial suppliers next. Ask the rest of them if you can negotiate payment terms.

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