Managing Cash Flow During an Economic Downturn
Were you aware that your business can make a profit while having a negative cash flow? In fact, most companies in a high growth phase often have cash flow problems as they invariably always need additional working capital to service their growth. A business could be profitable but profits could be eaten up by movements in the balance sheet such making sales on credit, the business using profits to pay off debt, the business using cash to buy assets or it could be that the business invested in too much inventory. It is important that you know the difference between cash flow and profit. We suggest you read Cash is King.
Your relationship with money is reflected in your financial statements as this has a direct relationship with your beliefs which influence your financial behaviour and consequently your financial decisions. As a starting point it is wise to deal with money issues up front, early and often. Once you shift your mindset from fear and scarcity to abundance and frugality and you review your relationship with money you will keep more cash. When we say be frugal, we do not mean be frugal at the expense of the service or product you are selling.
In this article we focus on the immediate actions you can take to realise and unlock cash flow within your business within 1 to 3 months. Cash flow is a challenge for many businesses and without it, your business will choke as this is the oxygen you need to keep your business alive. A cash flow crisis is even more challenging for small business owners and they do not always have the shock absorbers that larger businesses might have - Most businesses fail because they run out of cash. Not only is this information a great resource during a crisis, but key elements you should consistently revisit to help you avoid long term cash flow problems. These are not academic recommendations, we have also applied these same practices in our practice so we know these are effective. Don't worry about having all the right answers immediately, as a business is always a work in progress and some of the oldest companies are still figuring it out themselves!
1. Implement Job Costing
At the core of your business is the cost it takes to deliver your services or manufacture your product. It is important to understand your labour cost ie, your fully loaded burden rate which factors in fringe costs of employment. The true cost of a person is not just their salary. It is the company tax contribution, insurance or workmen’s compensation, benefits, uniforms, training and development, and many more "burdens" of employment which could be unique to different types of businesses. This is the biggest reason companies make losses or do not achieve their margins. You should be tracking the time spent on a job so that you can identify where your costs are leaking. This allows you to see who or what is causing you cash flow problems and contributing to profitability. A good decision where you identity low margin customers is to have a fee review discussion or to fire them if they are not willing to pay a fair price for your service. If you are selling a product, you could increase your price but if the price would become uncompetitive as a result your options would be to either look further into your costs and renegotiate prices with suppliers or discontinue low margin products. Yes, we know, it sounds irrational to let go off that cash flow especially as a small business but your focus should be on acquiring high margin customers or product lines.
A knee jerk reaction to a cash flow crisis is to panic and give customers discounts. The reality is most small businesses have already got narrow margins because of incorrect pricing. When you have cash flow problems, accepting work at a discount or selling products at a discount to keep your people busy does not necessarily convert to positive cash flow. If you do this, you will have to generate more sales to achieve the same profits. We only recommend this where you are intimate with your margins and you can make an informed decision. A result of proper job costing is also that you will start to review your pricing and over time, with constant monitoring and reviews, you will start to realise improved margins as a result of informed pricing.
2. Optimise your Operations
An unintended consequence of job costing is also that you start to improve efficiencies, monitor gross profit margins more closely and uncover unproductive resources or areas of wastage. Once you start to implement job costing the next step is to optimise your operations. So what does it mean to optimise your operations? Successful delivery of your product or service is primarily controlled by your operations function. While your marketing efforts get you the sale, operations meets the customers expectation. You need to focus on continually improving activities that lead to delivering the products and services to your customers, rework your operational processes to become more efficient and as conditions change, adapt and add to your processes. As you repeat the cycles and create a flow you begin to free up more time and resources to improve overall productivity and minimise costs.
Often small businesses tend to disregard this but an inefficient or under-resourced operation has a direct influence on your finances and can be the difference between a thriving business and one that is struggling to make ends meet. We would go as far as to say this could be the single most effective way of improving your cash flow. In fact, in our experience, even making new hires helped to improve cash flow, as much as that seemed like a crazy decision to make. As we focused on optimisation we began to realise that there we bottlenecks in our service delivery process and as a result, we had a lot of work in progress due to scarce resources. What we did was hire more competent and productive team members but set very clear and measurable targets and also experimented with moving away from a fixed model of compensation and adopted a per job or per hour compensation model. With time, this decision began to unlock cash flow.
3. Optimise your Cash Flow Cycle
"Our customers never pay on time!" - This is the biggest complaint we hear from most small business owners. When you are in a pinch you want to tighten your cash flow cycle while also increasing the percentage of customers paying on time by lengthening the time before you must pay your bills and shortening the time in which you get paid. This is also known as slowing your burn rate. A burn rate is the speed at which cash is reduced and your cash runway is the amount of time you can operate before you run out of money, given your existing conditions. Having a healthy cash flow is having a delicate balance between the rate and timing of cash coming in and going out. Here are just a few strategies you can implement slow down your burn rate before looking for external loans or funding in the absence of new revenues:
Monitor your accounts receivable ageing and know your average customers days. Simply put, this is how many days it takes you to collect from your customers. For everyday your customer doesn't pay, you are giving them a loan. You should be aiming to decrease the lead time between invoice and payment as in reality, the longer a customer does not pay, the more unlikely it is that they will pay you. You should be continually reviewing your customer ageing report and calling all customers who have fallen behind to secure partial payment and arranging payment plans if they cannot pay you in full. Invoice customers as soon as you can or in advance so that you are not losing days or weeks of cash flow. You could also take a page out of Tesla's playbook and take deposits from customers upfront.
Automate invoicing and collections by using accounting software. This streamlines your processes and reduces your cost of accounting. Couple this with automated payment reminders which are demonstrated to increase customer early settlements. You should also implement payment merchant services like Payfast, Peach Payments, NetCash, and Paygate, as an additional payment method so that it is more convenient for customers to pay. These do come at a cost but this far outweighs the cost of not getting paid on time. Your stress levels are lowered, you are not in fight or flight mode so that you spend your energy and resources on being strategic
Accelerate collections by recommunicating your payment terms to customers and getting their buy in. Practice the 3 F's - Be Firm, Be Focused and Be Friendly - "You will get more bees with honey than you will with vinegar".
Audit discretionary expenses by taking a deep dive into your management accounts. Discretionary expenses are expenses that a business can get by without, if necessary. These might have been a nice to have but doing away with them will not affect the business. For example, to promote goodwill with customers a company might invest in customer gifts. When assessing what a discretionary expense is it’s important to question the purpose of an expense, for example, while marketing might often be construed as a discretionary expense, how would slashing this affect your revenues? The answer will always be different for each business depending how effective that marketing function is. Be mindful of classifying an expense as discretionary when in fact, it contributes either to your revenue or your ability to deliver a service or product.
Manage the timing of cash going out the door. Don’t pay your suppliers until payment is due, and not before. That is not so say pay late, as this could compromise your relations with your supplier or service providers and they will be less inclined to be lenient with you in the future. Have an honest conversation with your suppliers, negotiate extended payment terms with them should your cash flow be throttled and stick to your agreement. You do not want to damage productivity when you can’t get the goods and services you need in order to deliver to your customers.
Purchase less inventory so that your cash is not tied up which affects your liquidity. Review your inventory trends to see if there are items that can be ordered less. If you are already sitting on excess or obsolete inventory, consider cutting your losses and selling it off at a discount, but don’t forget to factor in your cost of carrying the inventory, so that you can recoup some of that cash.
Before considering your long term solutions like taking on debts these are some of the things you can do because if your business has an intrinsic problem with cash flows this will only act as a band aid and you would have dug a deeper hole for yourself. Also consider that it takes time to secure extra working capital so these are things you can do right now.
The above will all be brought together by a proactive approach to budgeting and forecasting. You should have at least a 6 week detailed forecast for the short term with a detailed customer by customer and supplier by supplier forecast so that you can make better decisions should you need to engage with them about payment terms. You should also have a medium term 12 month to 18 month forecast so you can plan ahead. As the saying goes, "An ounce of prevention is worth a pound of treatment" - Take steps to proactively prepare for or prevent cash flow shortages, leverage on financial intelligence by measuring and monitoring key performance indicators, and improve operations management. If you don't already have a forecast, that’s ok, now is the time to do it and put it to work so you can start implementing your good business planning practices.