WHY IS CASH KING FOR SMALL BUSINESS?

By Paul Cunningham, Associate, SMART Business Solutions

Cash flow is an essential measure of a business's strength and must be regularly reviewed and improved to ensure the organisation not only survives but thrives. As one of the Associates at SMART Business Solutions, Paul Cunningham knows first-hand how a strong cash-flow position is crucial for business’ ability to weather any storm.

Most business owners understand the importance of cashflow, yet often in the day-to-day running of the business, their cash-flow is overlooked due to product or service development, or in their efforts to make another sale.” Paul said. “According to Xero Small Business Insights, only 49.8% of Australian small businesses were cash-flow positive in February of 2020 – before COVID lockdowns.

Many business owners respond to negative or low cash-flow with the response of needing to drive sales. Whilst this can help in some circumstances, sales revenue is only one driver of cash-flow. It is imperative that business owners take steps to ensure they are looking at other drivers that may be hurting their cash-flow.

In my experience in assisting business owners in improving their cash-flow, the following four actions are crucial to create meaningful change:

1. Understand how the cash-flow in your business works;

2. Prepare a cash-flow forecast;

3. Set a cash-flow improvement plan by setting goals and targets that will result in better cash-flow; and

4. Review the cash flow forecast and monitor your improvement plan.

The first key component to understand is that cash-flow does not equal profit. Payments of GST, loan repayments and the purchase of assets will not affect your overall profit but will absolutely affect your overall cash flow.

Similarly, a sale where cash is not yet received will affect your profit but will not affect your cash-flow until the payment is received.

The second key component is the cash-flow conversion cycle. It measures the days between when you make payment to your supplier (or other costs to produce a product) to how many days before you receive the cash from your customer.

The more days in the cycle, the longer your business is waiting before receiving the reward for funds you have already spent. For example, if after purchasing or producing your product you are unable to sell your product for 30 days, and then your customer takes 45 days to pay you, your cash conversion cycle is 75 days. For many businesses, 75 days is a long time to wait between initial outlay of funds to finally receiving cash in return.

If a business can reduce the number of days in the cash conversion cycle whilst maintaining their profit margins and sales, they will benefit with improved cash-flow.

Once you understand cash conversion cycle you can begin to document a cash-flow forecast. A good cash-flow forecast should identify the points in time where cash-flow may be of concern. This in turn helps a business take steps to rectify any issues in those points to help them manage their costs better. For example, a garden maintenance business may identify low points in their cash flow in the winter months. They may consider introducing some marketing or develop a service that targets those low points in time which is aimed to steady their cash-flow.

Start by identifying key drivers that impact the businesses cash flow and consider how they can be reviewed and improved. Each business will be different in the types of drivers that will significantly affect its cash-flow. The following are two examples of key drivers which I believe many business owners could review to improve their cash flow.

Average Debtor Days

Average debtor days measures the days between issuing an invoice and receiving payment. Below is a list of essential action items you can take to improve debtor days:

> Ensure the invoice terms are clear and that your customers understand them

> Ensure you are billing customers promptly

> Offer easy payment options (consider online merchant facilities)

> Use invoice reminders - accounting products such as Xero offer automatic reminders

Overhead Expenses

Business owners should review their overhead costs to help improve their cash-flow. You can start by preparing a spending budget and look for areas where costs can be reduced or eliminated.

Be thoughtful with where you cut back. Some overheads will be drivers of value in your business such as marketing, accounting or business coaches. Avoid harsh spending cuts for the sake of it – consider if there is value there first. A great example is whether or not you would use a bookkeeper. Whilst you may be able to minimise your overheads by doing the books yourself, it’s important to consider the opportunity cost of the time you need to invest in self-managing your books. This is time where you are not actively working in or on your business. Unless you already have the skills and training to manage your own books it may be money well spent having a professional performing an essential task in half the amount of time that you would manage yourself.

By no means are these the only two drivers that impact your cash-flow. I would definitely recommend getting advice from a professional who can help you understand and monitor the key drivers in your business. A good accountant is worth their weight in gold. Cash-flow really is the life blood of any business. It holds the key to business survival and adaptation, and the key to delivering overall value to business owners.

More information

Paul Cunningham, Associate SMART Business Solutions

www.smartbusinesssolutions.com.au