Turnover is Vanity. Profit is Sanity. But Cash is King. Most of us are familiar with the saying. Cash flow management 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 cash/cash flow rather than income or other financial measures.
According to SEDA (Small Enterprise Development Agency), startups fail at a rate of about nine in 10 in the first two years of operation.
As we are approaching the end of 2019, operations across various businesses are starting to slow down. This begs the question: “Why is effective cash flow management so critical to a small business, especially one that is new or growing”?
Having too little or too much cash is often cited in the top reasons why a small business fails. Good cash 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 a very time-consuming process and is usually disruptive to managing the ongoing business. Once you have raised funds, use them wisely so you can spend time managing and growing the business, rather than being on a continual fundraising treadmill.
What are the top misconception people have about cash flow management?
Misconception #1 – Cash flow management is a foreign language, and you need special skills to calculate it: In fact, cash flow is easier to calculate than income with all its accounting rules. You have the cash, or you do not. Forecast the cash coming in and the cash going out, and you have it. Of course, you need an understanding of your business and what makes it tick. But you need to 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 extend 12 months – a rolling 12-month forecast. If the company has cash issues, the cash projection might be every week – will you be able to make payroll, etc.?
Misconception #3 – If your company is profitable, you can’t have a cash flow problem: Unfortunately a lot of new startup companies think this way. See the response in the section below.
Can a business that has many customers and is 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 product 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 at the same time.
What are some of the common mistakes business owners make when it comes to cash flow management?
Mistake #1 – Not having a monthly cash flow forecast extending 12 months forward: It’s important to be able to see when cash shortfalls might be occurring so you can take effective action. Unless you are funding the business from your personal account, most 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, then you will have no option but to fund the company yourself – or accept whatever terms are demanded by a funder.
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 have top of mind what the cash impact of her decisions/actions will be.
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 in advance.
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, not willing to take some risk in new opportunities. Or if you go too far, you might not make well-thought-out investments/expenditures (e.g., hiring staff well before have 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. Especially if you are operating in South Africa’s current economic climate. There is constant change. Therefore, in the budget provide contingencies – assume not all sales will happen, and more expenses will be needed.
Mistake #6 – Not completing the items listed in the next question as part of good management practice.
What are some ways businesses can 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 to use during the inevitable downturns. Open a notice/investment account that gives you some interest return on the excess cash. Think of the ant. Store provisions in the good times so that 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 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 annual contracts, try for 2-3 years. Try to get some payments upfront.
- Provide several payment options for customers – credit card, PayPal, wire transfer or some other form of 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 you need to invest 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 for you to pay back the debt that 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”?
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 that will alert you when there might be cash flow difficulties or opportunities. Take action now to prevent the negative and position yourself for the opportunities.