“YOU can report losses year after year but you only run out of cash once.”
This quote from REL Consultancy Group neatly sums up the critical importance of ensuring business cash flow is properly managed.
A recent international survey by REL indicates that even large businesses struggle to come to grips with this issue.
It found that 75 per cent of multinational corporations admit to having little or no confidence in their own cash flow projections.
The major causes include a lack of systems integration across business units, poor internal communications, and poor sales projections and collections policies.
“It is alarming that cash flow forecasting, the most reliable indicator of corporate health, still plays second fiddle to profit predictions,” REL director Alexander Bielenberg said.
Ian Hartley of Computer Accounting Doctor, a mobile accounting service, agrees that cash flow is the single biggest issue for business owners.
He believes business owners and managers who want to make a consistent and measurable improvement to their cash flow need to adopt a strategy rather than reacting in an ad hoc manner.
Mr Hartley adds that cash flow plans should not be confused with budgets.
A budget is a projection of expected sales and costs for a defined period and is measured in terms of profit and loss.
In contrast, a cash flow plan shows how and when income goes into the business, as well as how and when payments are made to suppliers and staff.
Businesses should have both a budget and a cash flow plan.
Mr Hartley defines a cash flow plan as a set of internal guidelines to control cash.
This means writing out rules in relation to paying supplies (creditors), receiving payments from customers (debtors), the amount of stock held in the business and dealings with the bank.
The next step is to isolate the cash flow issues that cause most concern and then seek to resolve those issues.
Mr Hartley recommends a lot of small improvements (see box) as often as possible rather than trying to make one big change.
For many businesses, one of the challenges is trying to define or quantify their cash flow or working capital needs.
Firms such as BDO Chartered Accountants and Business Advisers can help in this area with what it calls its diagnostic software tool.
Manager Chris Paterson said the software could be used to analyse the performance of a business, starting with its budget and producing forecasts for profits, debt, cash flow and other key indicators.
This process can be used to identify any areas of concern.
If a business needs to reduce its working capital requirements, the software can be used to quantify the impact of possible strategies, which would include increasing prices, improving receivables collection, reducing inventory holdings, or renegotiating arrangements with suppliers.
“The real value comes from developing achievable strategies,” Mr Paterson said.
“A lot of people think they will just go out and increase sales, but increasing margins by two or 3 per cent may give a much better result than increasing sales by 20 per cent.”
Mr Paterson said one of the risks in running a business was growing too fast.
“If you are growing, regardless of how well you run the business, your working capital needs are always going to go up,” he said.
“You need to ensure you manage the growth so that it is sustainable.”
The ideal position for a growing business was where the cash generated from operating profit was sufficient to drive the growth of the business.
In some cases it may not be possible for a growing business to achieve neutral or positive cash flow.
“If we can’t reach the goal, we go back to the client and tell them the expected cash flow shortage,” Mr Paterson said.
“That is the time for the client to go to their bank and arrange an increased overdraft, instead of waiting for the problem to arise and then trying to deal with it.”
Alternatively the business may focus more on improving its efficiency or its gross margin rather than lifting sales.
Mr Paterson said some businesses could focus too much on working capital, to the detriment of their business growth.
For instance, they could reduce their inventory holding to such an extent that they lose sales because products cannot be supplied on time.
They could also be too aggressive in chasing debtors, to the extent they damage business relationships.
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