Avoiding the cashflow crunch

It’s a feeling every business owner knows. The monthly wages bill is due, the work car has just broken down and that big debtor is taking their time to pay when, from nowhere, in lobs an unexpectedly large tax bill with 21 days to pay.

Sure, it’s a temporary cost hump – but is there enough cash in the bank to pay?

At its heart, cash flow management is simply a matter of making sure your business has enough cash to meet expenses when they need to be paid. Sounds easy, right?

For business owners with a functioning crystal ball, perhaps. For everyone else, keeping track of hundreds of expense and revenue items, each operating according to its own highly uncertain timetable, can be a difficult and stressful exercise.

But there are many simple things a business owner can do to put their business on a steady cash flow footing. From updating financial reporting systems to sending out bills on brightly coloured paper, it is easy to reduce the risk of a sudden cash squeeze.

The cash flow budget – every business’s best friend

The first step to improving cash flow management is to know your business’s balance sheet back to front. This may sound obvious, but according to business analyst and author Michael Burdette, many people don’t know what they need to know when it comes to cash flow.

“Often small business owners have a passion for providing a service or a product rather than a financial background and it can glaze their eyes over – until they get into trouble,” Burdette says.

The error many people make is to focus on their businesses profit and loss statement to the exclusion of all else. It’s a potentially fatal mistake because healthy profits can mask an incipient cash flow crisis.

Burdette says profit and loss statements do not usually contain the information required to make an adequate cash flow projection.

“To get across cash flow, you must start with a properly structured balance sheet that has all the detail, from inventory and debts to interest costs. You must know and understand the numbers. Business owners often think that’s what their accountant is for, but they couldn’t be more wrong,” he says.

Only with a comprehensive balance sheet in hand is it possible to construct a useful cash flow budget. Sometimes called a cash flow projection, this vital document is a “best guess” at a business’s cash inflows and outflows over a period of time.

CPA Australia SME spokesman Paul Orfanos says business owners should update and review their business’s cash flow budget on a regular basis using conservative revenue and expense estimates. This will not only provide an early warning system for potential cash shortages, it will also help build your business’s credit track record, useful information when asking banks for credit.

What bookkeeping programs won’t tell you

Mainstream bookkeeping programs such as MYOB and QuickBooks, while a useful part of many SMEs accounting processes, are not equipped to perform a cash flow budgeting function. This is because their central function of producing profit and loss and balance sheets for tax compliance purposes means they are essentially backward looking, Orfanos says. “Managing cash flow requires forward planning and forecasting of future business sales and purchases.”

And, Orfanos says, unless you have particular skills it is generally not a good idea to just construct your own cash flow budgeting system using basic spreadsheet software such as Excel. “Spreadsheets can assist, but there is no rigour or structure and they are prone to errors,” he says.

In many cases, it will be useful to buy tailored cash flow budgeting software such as My Business Manager or Cash Forecast. My Business Manager chief executive Ian McManus says the advantage of these kind of programs is that they are designed to produce useful management information. “Software like MYOB is getting better, but it can still leave a person without financial training unclear about what they’re seeing – often they just look at the bottom line to see if they made a profit, but a lot can be hidden behind that figure.”

How often should you put together a cash flow budget?

Of course, there is an alternative to building up your software skills: spend more time with your accountant. Businesses that enjoy predictable cash flow can often operate perfectly well doing cash flow budgeting on a quarterly basis, and because your accountant will already have much of the necessary information in order to prepare your BAS statement, a useful three month cash flow budget can often be prepared at the same time at minimal additional cost.

David Knowles, a partner of accounting firm Pitcher Partners, says the greater the cash flow uncertainty a business faces, the more often a new cash flow budget should be prepared. For the average business, he says, this will mean quarterly or monthly cash flow budgeting, but for cash flow management requires more frequent attention.

“If cash is really tight we recommend doing weekly cash flow projections,” Knowles says. “At that level it is really about which invoices you‘ll pay and who will pay you, balancing bank balances and even making sure you don’t have cheques sitting on a desk waiting to be deposited. That micro-management can be time-consuming but many SMEs find they need to do that from time to time.”

Growth requires cash

Although a failing business will often run into cash flow difficulties, rapid growth is just as likely to result in a cash crunch. Knowles says he finds business owners often don’t have an appreciation of the cash flow implications of growth.

“When businesses grow, a lot more cash starts coming in the door, so it’s easy for business owners to imagine all their cash flow problems are solved. But meanwhile stocks are running down and debtors are not being chased,” Knowles says. “Strong sales this month often means a cash shortage next month. Most SME owners don’t expect that.”

The answer, Knowles says, is to understand the consequences of growth and carefully monitor your business’s cash status. “It is generally possible to obtain credit from suppliers or banks to deal with cash shortages in these situations, but you can’t do it overnight,” he says.

Improve your business’s cash flow

In the end, all the forecasts and accounting programs in the world are no compensation for getting more cash in the door. Here are some tips on how to improve your business’s cash flow.

1. Set your credit terms carefully. The need to extend credit to customers is a fact of life for most businesses, but it is important to set clear limits. Carefully research the standard credit period for your industry and make an honest assessment about the consequences of shortening your credit terms. Reducing your payment period from 90 to 60 days might lose you one customer, but if the other 99 will pay more quickly it could be worth it.

2. Make your debtors pay quickly.

It is vital to master the art of debtor management. One suggestion is to ensure debtors know how much time they have by sending payment notices on different coloured paper – with 30 days to go, send a blue notice, 15 days an orange notice and bright red when payment is required immediately. Talk constantly with major debtors as payment deadlines approach, and perhaps pass by; the squeaky wheel often gets the oil. A small discount for early payment can also provide an effective incentive to put that cheque in the mail.

3. Pay your creditors slowly. No one ever said business was fair. Take advantage of credit terms where you can and prioritise costs according to the severity of the consequences for not paying. Wages, taxes and direct debits are at the top of the list, key suppliers second and everyone else last.

4. Smooth out the lumps. Know when lean cash flow patches are coming and plan accordingly. It is invariably more difficult to get debtors to pay at BAS time and over Christmas, so make sure you have a bit of leeway in your cash accounts to pay wages and other inflexible expenses during these periods. Equally, avoid funding major purchases from your business’s working capital unless you are sure you have the cash to cover it.

5. Use finance products effectively. Overdrafts, premium funding, lease facilities and cash flow funding products can all be excellent tools to help match a business’s cash supply with planned outlays if used sensibly. Even the business credit card can be a good way to ease the squeeze as long as you are sure the debt can be paid before interest kicks in.

6. Do not incur penalties. The Australian Taxation Office and the Australian Securities & Investments Commission both impose penalties for late lodgements or payments in some circumstances. Paying these debts first will save you money and stress.

7. Keep your hands out of the till. Discipline yourself to make cash drawings only in line with conservative cash flow forecasts. Cash drawings are effectively just another expense for your business and should be treated accordingly.