Turnover is Vanity. Profit is Sanity. But Cash, Cash Flow is King. Most of us know the saying: Adequate cash flow is the key to success for many new and growing small businesses. Cash is the fuel that makes any new business work; hence, these businesses should be managed with a primary focus on adequate cash flow management rather than income or other financial measures.
Yes, wee Cash Flow is King!
The failure rate of businesses in South Africa varies depending on the source and the definition of “failure.” However, according to a report by Business Partners Limited, a South African SME risk financier, the failure rate of small and medium-sized enterprises (SMEs) in South Africa is estimated to be around 60% within the first two years of operation. This report also stated that approximately 90% of SMEs fail within the first five years of operation.
According to a 2018 report by the Small Enterprise Development Agency (SEDA), the failure rate of small businesses in South Africa is around 60% within the first three years of operation.
A 2020 report by the National Small Business Chamber (NSBC) found that the failure rate for small businesses in South Africa is around 80% within the first 18 months of operation.
A 2020 report by the Global Entrepreneurship Monitor (GEM) South Africa found that about 37% of new businesses in South Africa fail within the first three years of operation.
Against this business failure background, new businesses start every day. When I completed my PhD studies in 2014, one of the most important reasons for this failure was the lack of access to funding and the inability of business owners to manage their cash flow effectively.
Thus, the question remains: “Why is effective cash flow management so critical to a small business, especially one that is new or growing”?
Good cash flow management brings stability to a business, which provides the ability to choose customers, vendors and staff, negotiate the best terms, plan for growth, etc. Cash resources available to new small to mid-sized enterprises (SMEs) are usually tight, so you need to know that you can meet this week’s payroll; pay vendor bills and take advantage of any discounts offered; take on new work, projects, territories, etc. to facilitate your company’s growth; and pay yourself (the Founder).
You should know the amount of cash you have in the bank at the end of every day. Fundraising is time-consuming and usually disruptive to managing the ongoing business. Once you have raised funds, use them wisely to spend time working on and growing the business rather than being on a continual fundraising treadmill.
What are the top misconceptions people have about cash flow management?
- Misconception #1 ― Cash flow management is a foreign language; you need special skills to calculate it. Cash flow is more accessible to calculate than income with all its accounting rules. You have the cash, or you don’t. Forecast the cash coming in and the cash going out, and you have it. Of course, you need to understand your business and what makes it tick. But you must know your business economics to be an effective and profitable entrepreneur.
- Misconception #2 ― You only need to prepare a cash flow once a year when you plan your budget. Not true. You need to project cash flow every month and have it extended to 12 months (a rolling 12-month forecast). This refers to the cash flow statement. The cash flow projection might be weekly if the company has cash issues. Will you be able to make payroll, etc.?
- Misconception #3 ― If your company is profitable, you can’t have a cash flow problem. Unfortunately, many new startup companies think this way and lack understanding, i.e., the true cash flow meaning. See the response in the section below.
Can a business with many customers and making a profit still experience cash flow issues?
Yes! It is often growing companies that are surprised when the cash crunch comes. As you grow, you will need to build more products for a product business or hire staff for a service business – in either case, it is in advance of making sales. Therefore, you are spending cash before getting paid.
Further, giving your customers credit terms exacerbates the situation; you have made the sale, but it might be 30 or 60 days before you receive the cash from the sale. You can talk about sales made, bookings, revenues, order pipelines, etc., but these are not necessarily cash received simultaneously.
What are some common mistakes business owners make regarding cash flow management?
- Mistake #1 ― Not having a monthly cash flow forecast extending 12 months forward. It’s important to see when cash shortfalls might occur so you can take effective action. Unless you fund the business from your account, other means to obtain funding take some time – a bank term loan, online lending, crowdfunding campaign, angel investors, etc. If you do not give yourself time to obtain outside funding, you will have no option but to fund the company yourself – or accept whatever a funder demands terms.
- Mistake #2 ― The Founder thinks that cash flow is the accountant’s job. The accountant reports on past activities. The Founder makes things happen going forward and needs to know the cash impact of her decisions/actions.
- Mistake #3 ― Not having a “Plan B”. If there is a cash crunch, how will you cope/handle it? What staff and expenses to cut, which vendor invoices to delay payment, and all other measures to conserve cash? Of course, you’ll need to update/fine-tune the list if/when a cash crunch occurs, but it’s good to have planned.
- Mistake #4 ― Thinking that you can never have too much cash. Too much cash is one of the reasons why companies fail. Maybe it is because you are too conservative and not willing to take some risks in new opportunities. Or if you go too far, you might not make well-thought-out investments/expenditures (e.g., hiring staff well before having product/service sales).
- Mistake #5 ― Thinking that events will be exactly as budgeted a year in advance: This is not the environment in which SMEs operate. There is constant change, especially if you are operating in South Africa’s current economic climate. Therefore, in the budget, provide contingencies – assume not all sales will happen, and more expenses will be needed.
- Mistake #6 ― Not completing the items in the next question is part of good cash flow management practice.
How can businesses address cash flow shortfalls and difficulties before it’s too late?
What you can do by yourself:
- Prepare cash flow predictions to alert you to possible trouble before it occurs.
- Build up cash reserves during positive cash flow cycles during the inevitable downturns. Open a notice/investment account with some interest return on the excess cash. Think of the ant. Store provisions in the good times so you have enough in the tough times!
- Prepare a budget, generally follow it, but do not be a slave to it. Take advantage of opportunities and pull back when appropriate.
Interface with customers:
- Send out timely invoices with correct information.
- Make sure customers know when payments are due (saying the invoice is due on 1 September is more forceful than saying the invoiced amount is due in 30 days).
- Monitor your accounts receivables, and call customers if late.
- Do a credit check on customers before selling to them.
- Offer discounts for prompt payment.
- If you have monthly contracts, try for annual; if you have yearly contracts, try for 2-3 years. Try to get some payments upfront.
- Provide customer payment options – credit card, PayPal, wire transfer or electronic payment.
Interface with Vendors:
- Take advantage of all prompt payment discounts.
- Negotiate for expanded credit terms.
- Pay all bills on time.
Interface with Bank:
- Get a letter of credit or overdraft, or if you have one, get a higher limit. The best time to get a Letter of Credit/Overdraft is when you do not need it.
Be Strategic about your Growth:
Rapid growth can often result in cash flow issues. Winning a new contract can mean investing in new employees, but net 30-, 60- or even 90-day terms can result in a payment delay and a cash crunch on payroll day.
Don’t shy away from growth opportunities, but use your cash flow forecast to keep an eye on how long it will take to pay back the debt you’ve incurred to grow. Look at each customer as an investment, and ask: “Am I making a profit, and how long will it take to collect it”?
Cash Flow ― The Conclusion
If you have it, you can operate and grow your business in an orderly manner and take advantage of previously unforeseen opportunities. If you do not have sufficient cash, it will be a scramble, and you will have to force tradeoffs between making payroll and other priorities.
Put together an ongoing cash flow forecasting process to alert you when cash flow difficulties or opportunities occur. Take action now to prevent the negative and position yourself for the possibilities.