Avoid a cash crunch

• Bernard Tanner
• 2 September 2009
• Page 1 of 2 : single page

Put 10 small business owners in a room and sooner or later the talk turns to cashflow. It's what they call a ‘barbecue stopper' - a real make or break issue that can have even experienced operators tearing their hair out.

A cashflow crunch is one of the main reasons profitable businesses fail. Even a temporary cash shortfall can cost you time and money as you scramble to close the gap.

When cashflow becomes a trickle

If you have challenges managing cashflow, you're not alone. Ask a small business owner about cashflow and here are some of the things you might hear them say: "I just don't understand it. I'm making plenty of sales, yet I never seem to have any money in the bank."

"I spent so much stocking up for Christmas, I couldn't pay myself this month."

"Sales are strong for most of the year - it's that slow period over January that kills me."

"We're growing so fast, I've had to put on extra staff, but it's going to be a while before they start paying their way."

"I spent so much stocking up for Christmas, I couldn't pay myself this month."

"My suppliers want cash on delivery, while my customers take months to pay."

Although the causes are different, all of these speakers have two things in common: they're suffering from a time lag between outgoings and income, and they don't have a tracking system in place to help control it.

Provided your business is profitable, all cashflow problems are essentially timing problems. Your job is to identify where the gaps are occurring, then either bridge or eliminate them.

Staying on track

You can't manage what you can't measure. So the first step is to create a cashflow tracking system. See Table 1 (below) for some of the things you should keep track of.

It can be as simple as a spreadsheet, or as sophisticated as the cash reporting tools built into many off-the-shelf business accounting systems. The key is to update and consult it regularly, then use it to predict your future cash needs.

What to watch

Once you've collected your data, you're ready to start calculating some key indicators that will give you a real insight into how cash flows in and out of your business. Here are some to watch:

• Your actual and projected cash balance for each month (cash in minus cash out).
• If you have stock on hand, your average stock turnover time.
• If you offer credit, the average number of days from making a sale to being paid (sometimes called your days debtors).
• Cashflow hotspots during the year. When does your cash balance rise and when does it fall? What caused the fall - a spike in outgoings or a drop in income? And what can you do to prevent it or prepare for it?
  

The cashflow cycle

The cashflow cycle (also called the working capital cycle, see Figure 1, below) is an incredibly useful tool for thinking how cashflow works in your business.

Here's an example to show how it works. Let's say you're a homewares wholesaler. You have cash in the bank from previous sales - that's the top of the cycle. Now you use that cash for rent, stock, salaries and all the other inputs that go into making your business run. That's the business inputs phase.

If things go to plan, those inputs begin to generate some new sales. Then, if you offer credit to your customers, you have to wait for those accounts to be paid. That's the accounts receivable phase of the cycle, and it's the biggest source of cashflow problems.

One of the great things about retail is that you usually don't have to worry about accounts receivable.

So, if our wholesaler has an average stock turnover of 60 days, plus an average of 60 days in accounts receivable, that adds up to a complete cycle of 120 days. That's a long time to have cash tied up in your business.

Now here's the important thing. Every dollar you invest in your business has to go around the cashflow cycle before it comes back to you, bringing some profit with it. So the faster you can make the cycle turn, the more successful your business will be.

Find the gap

Different businesses typically experience cashflow gaps at different points in the cycle. See Table 2 (below) for some examples. Take the time to analyse your own cashflow hotspots. That way, you can make sure you never suffer a cash crunch. Table 3 has the solutions to the most common cashflow problems.

Keep financially fit

No matter what the economic climate and despite business performance, it is important to conduct a financial health check regularly.

It is also advisable to conduct a similar process on the system you're adopting, to satisfy any concerns about security and financial efficiency.

Ultimately, this is a good way to gauge whether your business has the strength to withstand any downturns in the wider economy.

Draw on the expertise of business bankers and other financial advisers. With a wealth of experience and knowledge about the financing requirements of businesses, these advisers can play an integral role in driving your business to success.

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Figure 1

Table 1: What to track

Cash sales: Fixed costs
Collections from accounts receivable: Wages and super 
Other revenue (for example, money from asset sales):

• Rent and utilities (power, phone, etc)
  
• Loan repayments and lease paymentsOther regular overheads (insurance, advertising, etc)
• Your drawings
• Variable costs
• Casual wages
• GST
• Marketing
• Materials and stock
• Other one-off payments

Table 2: How cashflow problems affect different industries

• Retailers: If you're a retailer and you run a cash business, you're in a strong position. Stock turnover is likely to be the crucial issue for you. Remember, all that money tied up in stock has a cost, even if you're not paying interest on it.
• Manufacturers: Manufacturers do it tough, with longer cashflow cycles than most other businesses. Not only do you have to pay for plant, equipment, rent, salaries and materials before making a sale, you also have accounts receivable to deal with. If you're a manufacturer, it's essential to monitor your position carefully and negotiate favourable terms of trade with key suppliers and customers. You also need a ready source of short-term cash, whether in the form of savings, an overdraft or a line of credit.
• Importers and wholesalers: Importers have their own special problems, thanks to the gap between paying for goods and getting paid - not to mention the frustration and uncertainty of dealing with Australia's transport bottlenecks. Even if you ask your customers for partial payment in advance, you're likely to be left with a significant cashflow gap. It could be worth asking your banker about trade finance options to help bridge that gap.

Table 3: The top 5 cashflow problems and how to solve them

1. No tracking system > You can't manage what you can't measure. Create a cashflow tracker. Keep it up to date. Consult it regularly.
2. Stocking up > The stock's on the shelf. Now where are the customers? Track stock turnover carefully and plan for future stock needs. Turn over excess stock as quickly as possible, even at a discount. Have a source of short-term cash ready to bridge the gap (for example, savings or an overdraft).
3. Seasonality > Business is slow this month, but staff still have to be paid. Have a source of short-term cash ready to tide you over when business is slow (for example, savings or an overdraft). Try to diversify your business to reduce seasonality.
4. Growth > It's a great problem to have, but rapid growth needs to be managed carefully. Use savings or a business loan to cover the costs of ramping up. Use longer-term lending solutions for capital assets and match the length of the loan to the life of the asset. That way, an asset can pay for itself over time from the income it generates.
5. Days debtors > Isn't it frustrating when bills keep coming in faster than the money your clients owe you? If you offer your customers credit, keep a close eye on accounts receivable. Create a system for following up late accounts. If possible, negotiate shorter terms of trade with key customers and longer terms with your suppliers. #