Cash Flow - the “secret” essential in business

Cash Flow - the “secret” essential in business
By John Harland FRCSA Director ERG Recruitment

I was at an SME conference a few years ago where a keynote speaker stated during his address that the majority of SME’s that go into receivership are profitable at the time. It was a sobering comment for someone who with little capital or assets, had just bought a business.
Over many years working for multinational and public companies, I was never concerned or required to understand the importance of cash flow. A couple of years on and I now clearly understand the absolute importance of cash flow to the sustainability of my business and wonder why this appears to be a closely kept secret to those who manage the purse strings.

I now keep a daily watch on my cash flow using a very simple Excel spreadsheet which I reconcile on a daily basis with the bank balance. It is very simple. From a starting figure I add cash receipts (in the bank). I then deduct cash expenditure. I do this on a weekly basis and extrapolate out to a three month rolling forecast.
The closest few weeks are obviously very accurate, as by and large these figures are known. The three month forecast is not too difficult as many of the larger payments are recurring. Items like staff salaries, rent, telephone, loan repayments etc., vary little from month to month, and are generally due at the same time each month. Larger payments such as temp wages (weekly), PAYE (monthly) and GST (Bi-monthly) are a little bit more variable, but are not difficult to predict. This is not rocket science and it allows me to sleep at night, but importantly, it also allows me to anticipate when there will be a period of short cash supply and when I will be in a position to spend. In other words my business plan is inextricably linked to cash flow.

Larger businesses may have the capacity to raise capital quickly or have the leverage to negotiate and secure large financing facilities with a bank, but in general, SME owners link their lives and assets to their business. Accordingly, it is essential to mitigate the risk of losing everything you have worked hard for by keeping a close eye on your cash flow.
Ultimately, you can’t spend what you don’t have and unless you are fully aware of upcoming commitments, you can easily spend money received that has already been allocated.

PAYE and GST are classic cash flow issues for most businesses. As clients do not pay you immediately it is not possible to put the necessary money aside. You need it for working capital to pay your creditors and you have to use money received which may indeed be required for future payments. If you are not entirely aware of your future cash out flow, you are inviting trouble.

This brings us to another critical cash flow issue, Aged Debtors. In general, we offer our services to other businesses on normal trade credit terms (i.e. 20th of the month following or similar) but we pay wages on a weekly basis, so we must find a way to fund the uniquely cash hungry aspect of the recruitment, and in particular, labour hire (flexible workforce) business. It is essential to receive payment for services rendered on a timely basis. If you agree to terms which are longer than your commitment to meet associated
payments you need to have a method of paying your creditors until you have cash in the bank.

As a general rule your average aged debtors should be less than 30 days, but 30 -35 days would be a sustainable level. If it’s above this level you may be exposed to potential bad debts and will probably have some cash flow problems as weekly wages and monthly PAYE will put increasing pressure on your cash flow.

The higher the average aged debtor days, the greater the problem and the cost of financing. It is a tiger eating its tail.
While it is essential for SME owners I believe that for large businesses and internationals it would be beneficial for Branch Managers to have an understanding of the cash flow in their branch. It will assist them to manage the business and understand the importance of productivity, debtor management, and the actual sustainability of their branch. It will give them the information needed to justify an increase in staff, beyond a guess, about future market growth, and conversely it will show them when the existing staff level/productivity is unsustainable. It will enable them to produce a business plan which is realistic and achievable and if each individual part of the business is profitable and growing, the entire entity will also be dynamic and profitable.

There are a number of situations which may require access to facilities to support your cash flow requirements.
1. Start-ups
Start-ups often have limited funding options. As bank facilities rely heavily on past performance rather than future prospects, start-ups often have to resort to re-mortgaging or asking friends and family to invest. This is an inherently risky approach as your future financial security is greatly exposed.
2. Growth
The key is to find the right fit for the business so finance arrangements support the business’s current needs and enable it to grow without undue constraint.
3. Management buyouts/Mergers and acquisition
4. Bad Debts/Loss of a major client
5. Owner(s) disputes or splits Banks are the traditional means of funding but are often made expensive or out of reach due to financial regulations and government action in respect of fiscal management. When they are available there are usually requirements for securities over property or personal guarantees that tie your personal financial security to the success (or otherwise) of the business.
Don’t expect banks to be sympathetic if your company gets into financial difficulty. Their responsibility is to their stakeholders.

The good news is, however, there are facilities in the market which lend themselves to the unique requirements of our industry and which in the past 25 years have become a mainstream funder to small to medium sized enterprises in the UK, US and Australia.
Debtor or Invoice financing (also known as factoring) is now an accepted method of funding growth and cash flow which still allows you to maintain control of your client relationship. These facilities are linked directly to your invoices and accordingly grow along with your business growth.

In general, they do not require guarantees or security against anything other than those invoices. Usually this means you get 80% of the face value of the invoice and the balance (20% less fees and interest) on payment. This provides the cash to run your day-to-day operations. These facilities will also work in tandem with your existing bank arrangements.

More than 4,500 Australian SMEs, with combined annual revenues of $65 billion,use debtor finance. Debtor and Invoice Finance Association of Australia and New Zealand (DIFA) figures show an estimated $7 billion in credit lines, up from $3 billion a decade ago. Providers range from major banks to small regional independents. Larger specialist debtor financiers tend to offer the widest range
of options, so they can tailor solutions to a business’ specific circumstances.

If you are concerned about your cash flow requirements contact the RCSA for guidance. RCSA has active Premium Supporters and supporters who will be happy to discuss their facilities.

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