Understanding Cash

Cash management can be challenging for many businesses, even in the strongest economic times.  In tougher economic cycles, cash flow can be even harder to navigate, and often shines a light on deeper issues that need attention in a business too.

Identifying solutions may not be simple, but an understanding the drivers will leave you better placed to respond with a plan of action to solve them.

• For those with a Business-to-Customer (B2C) model, when consumers are reducing their household spending, it quickly affects daily takings and monthly projections.
• For Business-to-Business (B2B) models, the businesses you deal with regularly are also looking at ways to optimise their processes and reduce their cost bases.
• Some businesses are B2C and B2B and must react to changes in both spending cycles.

So, how should a business react to changes in cash flow?   Are they short-term or seasonal, or part of a permanent change?

Factors that affect Cash Flow

There are typically four main reasons why a business is short of money.

Working Capital ("WC") is the lifeblood of business. In simplistic terms, WC is defined as Current Assets minus Current Liabilities.  Poor working capital management has caused business failures, even when the financials show a profit. 

Business owners often sacrifice salaries or dividends to manage a working capital cash shortfall, hoping that 'things will turn around'.

No amount of efficient WC can be a substitute for a good revenue model, sufficient gross profit and effective cost management. Your business model and profitability tracking are the foundation of a sustainable business.

TIP: You can find a deeper understanding of Working Capital Days, Working Capital Remediation and Operating Performance covered in our previous blog:
How Much Cash does my Business Need?

3. Growth Pains

When your business grows, it sees increased sales, more inventory purchases, and more considerable debtor amounts to collect. This growth may lead to increased profits and a higher need for working capital.

In other words, it's a good problem, but it needs more consistent cash to flow for growth to continue.

4. Under-Capitalised

Many businesses are structured poorly from a capital and funding perspective. Business owners must be realistic about how much capital or dividends they remove from a business or contribute to it.  Debt and Equity are not the same.

Each has unique characteristics that must be managed mindfully for long-term success.

Understanding Products & Customers

The good news is that it's possible to trade your way out of a cash shortage - but you must also make changes. Along with effective cash management, seek to review and grow your products and services.

Effective Growth

The avenues for business growth can be grouped into the four categories shown below. Work your way through each and be prepared to seek support from a business mentor and your accountant. Talk to your employees, survey your customers, listen to business podcasts and be open to new ideas.

The Product / Customer Matrix

Borrowing to Grow

Challenging cycles require planning to know if you need to put more money into the business. Take what you have learned from analysing Working Capital, Operating Performance and Growth, and use this data to make an informed decision.

Sometimes, rushing into debt is not the answer.  A business may structurally be under-capitalised, meaning it needs a long-term and sustainable approach to be ready to make the most of funding and handle the repayment commitments.  A good commercial broker and business accountant can work with you to prepare ahead of time.

The Five Strategies for Better Cash Flow

When times are challenging, it is easy to get caught up on working harder in the business, instead of finding space to work on the business. Take manageable action and invest a few hours a week to devise a plan.  Work through the following strategies and optimise your financial position.

1. Identify your Permanent Working Capital – Is it changing?

This may be due to growth, credit/supplier terms or changed business circumstances. To take action on a problem, you first need to know the size of the problem. If the business is growing, you may need to leave more cash in the business.

You can't use debt to fill this hole, a mistake many advisers and business owners make.

TIP: Understand your business's normal working capital cycle and plan to keep that cash accessible in your business.

2. Remediate any weak areas of your WC Cycle

Determine if the weak areas are excess inventory, slow paying customers, short supplier terms, a combination of these or something else?

As an example, one of our customers had strong Profit results, but was short on Cash. A review showed that their Debtor days were pushed out to an average of 75 days. By implementing and enforcing a new collections policy, they reduced this cycle to 53 days for an annual savings of $185,000.

TIP: Be prepared to adjust to a new normal when required.

3. Operating Performance - Take an honest look at the Profit & Loss

Bringing in more cash may not be the best solution in the long term.  Could it be the time to make hard decisions? This may include a closer look at your Gross Margin Percentage or Gross Profit Operating Costs.

TIP: The very best businesses always "Focus on Revenue" along with costs.

4. Finding Capital for Growth

An honest discussion with family members, an accountant or a business adviser may be needed if your business is under-capitalised and needs more Equity or Capital contribution.

TIP: If business growth is the best strategy, then an Equity strategy, (not Debt), may be the answer.

5. Develop Habits for Financial Hygiene

There are day-to-day financial habits that we know we should do but either don't know where to start or feel too overwhelmed to find the time. These include:

• Using the right type of cash flow forecast for your business;
• Reviewing borrowings to get a better deal, including understanding your debt amortisation profile;
• Tax planning and reporting;
• Supporting personal cash flow by 'paying yourself first'; and
• Setting realistic business goals that acknowledge the hard truths.

TIP: You don't have to go it alone. Reach out to experts who can help.

More Information?

E - enquiry@mcpfinancial.com.au
W - www.mcpfinancial.com.au

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