The 7 Key Causes Of Poor Cashflow

René Artz from Westpac looks at financing growth in your business

Many new franchisees will develop a cashflow forecast which shows them what they need to get started. But if there’s no improvement plan, regular monitoring, or process analysis to make lasting adjustments, then the business risks finding itself unable to access further cash as it grows. So how do you avoid this? Let’s have a look at some of the basics.

Every business, regardless of what it does, has a Working Capital Cycle (WCC) which ties up available cash. Start any business, and cash is required to purchase stock, equipment or pay wages to generate a sale. When the stock is sold, it is either by way of a cash sale or is charged to an account, creating a debtor. When the debt is collected the WCC continues.

Imagine that the stock a business buys sits on the shelf, on average, for 55 days before it is sold and that it takes an average of 45 days to collect upon debtors (in a service business, the ‘stock’ may be work in progress). In this example, each dollar tied up in stock will take 100 days before it returns to the cash position where it can be used again to purchase more stock.

While we wait for that dollar to return, more stock must be purchased to keep the business operating. The more you grow, the more cash you require to fund the stock you need to grow. Using a bank overdraft, trade or debtor finance to provide this cash costs the business money. Without a proper working capital facility in place, a business may tie up funds that could be better used elsewhere, thereby slowing growth in sales.

Improperly managed, especially during growth, the WCC can be a key business constraint and the cause of a cashflow crisis. The key is to speed up the WCC, because the faster a dollar returns, the less overdraft or surplus funds the business is required to use. Here are seven key tips.

1. Stay on top of receivables

Accounts receivable are what the business is owed (debtors). If you have poor accounts management processes, this will result in the time between billing and banking being too high. Review your billing processes to shorten this time. Some strategies to help achieve this are:

• Offer customer options for prompt payment;

• Suggest direct debit for repeat custom;

• Issue invoices on the first day, not a week later;

• Charge an upfront deposit;

• Create and communicate a clear terms of trade policy with customers;

• Put credit control procedures in place to minimise bad debts;

• Always check credit references;

• Collect overdue debts and work with customers to avoid recurring issues.

A good franchise will have processes and procedures in place for managing accounts receivable. Follow those systems – it’s what the franchise model requires to succeed.

2. Don’t spend more than you need

Accounts payable are what the business owes to others – your trade creditors. To improve performance in this area, look to extend credit terms or reduce cost of purchases. A few areas to focus on include:

• Review and extend terms you receive from suppliers;

• Ensure you maximise any prompt payment discounts from suppliers;

• Implement expenditure budgets.

Buying power should be one of the biggest benefits a franchise offers, helping you reduce costs, access the best terms or receive promotional support.

3. Manage your inventory

The stock a business holds is called inventory. Carrying stock or sitting on Work In Progress (WIP) too long ties up funds, so these are prime areas for review. A key driver here is inventory turnover – the speed at which your stock sells. Any slowdown in your stock turnover rate can result in significant amounts of cash tied up. Some options to look at are:

• Review WIP and apply interim billing where possible;

• Review stock ordering by applying ‘just in time’ and other control processes;

• Outsource certain functions;

• Improve stock forecasting through sales pipeline management;

• Build supplier relationships for extended terms of credit;

• Apply stock management systems for centralised monitoring;

• Source additional finance when required, eg. for seasonal variations.

Developing these systems, monitoring and responding to them is a big job for an independent small business owner. Most franchises will already have such systems in place – use them.

4. Review your debt/capital structure

It’s something that’s easily neglected when you are so busy growing your business, but reviewing your term debt profiles occasionally can make a big difference. Look at the duration of amortising loans, and ensure these match the lifecycle and the cash flow that these assets provide.

You should also review shareholder drawings with the aim of retaining profits on the balance sheet to maintain equity levels that can finance and facilitate growth. This is especially relevant when you generate revenue by leasing plant or equipment that has an extended payback period.

This is an area where franchisees need to work with their own accountant on a regular basis to match business performance to personal situation. Take advice and listen to it.

5. Benchmark your overheads

Every business should benchmark its overheads, whether floor space, marketing, technology platforms or monthly subscriptions. Dig into your expense items and you will often find efficiencies to be made, which result in cash savings and reduced finance needs.

Benchmarking is a huge advantage of being part of a franchise. By seeing what others are achieving, you can not only learn what’s possible – you can find out how they are achieving it from people who are running exactly the same business but are colleagues, not competitors.

6. Don’t be a busy fool

Gross profit is what is left from sales after you deduct direct material and labour costs. If your gross profit margins are too low, you’ll be working harder for less reward. Every franchise system will hold gross profit benchmarks for a given level of revenue. Make sure you track your relevant benchmarks, and aim to achieve or better these figures.

Work with your franchise field support team to review labour scheduling, efficiency, product costing and all the key measures. Don’t be shy – their job is to help you improve.

7. Improve sale outcomes

All businesses exist because of sales to customers – it’s the one function that supports everything else. However, if the level of current sales doesn’t support the current overheads and cash demands of the business – including finance costs – your business may not be viable.

To grow sales, review how your business can generate further leads, retain more customers, improve sales lead conversion, increase customer transaction frequency and optimise pricing strategies. Again, work with the franchisor team – a few small changes across each area can produce a big improvement in profitability.

Create a cashflow budget, and you’ll find it will become one of your most powerful ongoing financial management tools. By reviewing it monthly, you will stay on top of your finances and may be able to avoid a cashflow crisis through the next growth cycle.

About the Author

René Artz is a Relationship Manager – Franchise, Hospitality, Tourism & Retail Trade for Westpac.

For more information, contact your local Westpac Franchise and Business Banking Specialist on 0800 177 007 or email: franchising@westpac.co.nz

The information contained in this article is intended as a guide only and is not intended as an exhaustive list of matters to be considered. Persons entering into franchise agreements should seek their own professional legal, accounting and other advice.