Solutions for Your Cash Flow Problems

"Financial success is not a hard science. It's a soft skill, where how you behave is more important than what you know.

We think about and are taught about money in ways that are too much like physics (with rules and laws) and not enough like psychology (with emotions and nuance)" Morgan Housel

Cash Flow Chaos

One of the key goals of business operations is accumulating cash flows from profitable trading.

Recently I came across a business where the inventory holding was 6-8 months of sales - with a likely problem of some obsolescence write-offs. Another time, a firm where receivables took on average 6 months to collect and the firm had to wrote off nearly $500,000 in uncollectible invoices which were several years old!

In the finance department of many organisations, Receivables collection, processing Supplier invoices and managing Inventory often involves transaction hurdles which ultimately affect cash flows resulting in adverse cash flow which can badly affect business.

Typical normal operational examples include:

• Customer contracts and contract variations not signed off before delivery;
• Defective work, damaged deliveries, short deliveries;
• Incorrect quantities shipped or prices charged;
• Late or missed invoicing after a construction project has been closed and handed over.
• Over ordering supplies of materials for production.

Even with the best systems and training, these system failures impact firms of all sizes; sometimes leading to insolvency, costly legal actions, stress and significant financial losses.

Management literature generally looks at the symptoms of cash flow issues and typically prescribe reactive fixes.

In this article, we look at internal systemic causal factors (see fish bone diagram below), along with external and internal factors which adversely affect cash flows. We examine some of the key value creation and risk management options which help prevent ongoing problems and improve profits and cash flows. We also look at the emergency fixes when unprecedented disruptions occur.

Hopefully, owners and readers will be able to implement some of these actions to improve profitability and cash flows. In doing so, keep in mind that business success is fundamentally driven by:

• Good management and culture
• Robust adaptable systems
• Internal capabilities delivering customer value every day
• A solid business model which evolves over time
• Innovation and quality improvement.

Truisms

It is worth keeping in mind the following:

1. Profitable businesses normally generate positive cash flow.
2. A profitable business can be insolvent if it cannot pay its debts and borrowings when due for payment; not enough profits and cash flows.
3. You can waste a lot of money and the firm still survives; thanks to big cash reserves.
4. A firm can be unprofitable and still survive; start-ups or large businesses with big financial backing.

Drivers of Cash Flows

Businesses succeed when they have good resources, capabilities, systems and effective management executing sound business strategies.

WHAT COULD GO WRONG?

Small to mid-sized (SME) firms need to be more cash conscious than large firms who have large cash reserves and access to finance markets.

Not so with SME's who must keep large cash reserves. This covers against most things that can go wrong along with cyclical variations in trading - seasons, Christmas and school holidays, etc.

1. Operations inefficiencies - Labour productivity, materials wastage.
2. Systems failures - poor contracting, pricing, product and service defects, theft.
3. Scaling without adequate resources, capabilities and systems. An example is a fast growing manufacturer which invested in a new factory with expensive equipment to triple capacity and produce a new range of food products in which it had no experience. It took months to learn to produce new products in larger batches, and in the process the firm wrote off millions in scrapped production which was not to customer standards.
4. External disasters such as pandemics, climate events and war are of course unpredictable. In many countries, central governments make allowance for these events (earthquakes in New Zealand), and fund mitigation and business recovery.
5. Internal disasters such as fire and large scale theft can destroy businesses without risk cover.
6. Economic downturns occur from time to time and require risk mitigation, e.g. recessions financial market crashes, and interest rate fluctuations. These can have dire effects on business profits and finances.

What to Do - Proactive Management

1/ Keep a large cash reserve - this has to be on top of cash cover for seasonal fluctuations.

This balance must keep you afloat for 6-12 months if disaster strikes (such as Covid lockdowns). I have clients who carry growing cash balances of millions of dollars, and occasionally I will remind them to pay dividends to harvest surplus cash.

If your firm does not have a large cash reserve, budget to accumulate one.

2/ Keep a running cash forecast 6 - 12 months ahead - surprisingly, a lot of firms do not do this. More in (3) below. This enables you to plan ahead for larger payments, seasonal dips in incoming cash, and putting money aside.

3/ Maintain a trading forecast 6 - 12 months ahead - keep updating your revenue forecasts in particular and link this to your marketing and sales prospecting activities. In contracting / project based businesses, you must have a pipeline of signed up work up to 12 months or more ahead. This ensures that your staff have ongoing work, and you are not paying wages for idle staff.

The longer your sales winning cycle, the longer is the pipeline required.

4/ Develop a good relationship with your bank. Keep them informed of how your business is going on a continual basis. When you need the bank, they will be more willing to lend money to your business.

5/ Have a reliable accounting system to provide you will timely and accurate information. You must be able to rely on key numbers to drive your business, and to provide to your bank for fund raising. The same system must give you history on customers, suppliers and inventory.

As part of your information system, the must have key numbers for decision making for value creation in sales, production and working capital management include:

• Sales
• Sales pipeline
• Marketing ROI
• Cost of Sales
• Labour efficiency
• Debtors Days Outstanding
• Months of Stock on hand
• Staff turnover and absence.

6/ Maintain tight control over spending, efficiencies and quality service delivery - SME's do not have the luxury of fat and wastage in their operations. Often SME's are more cost efficient and competitive against large companies.

7/ Innovation and Continuous Improvement - Listen to customers and staff and watch competitors and global trends. By continuing to improve products and systems, your firm will develop greater customer following and grow your profits and cash flow.

8/ Have great customer service delivery and cash collection - The best companies ensure that their product and service delivery is of the highest quality so as to have happy customers and strong brand reputation. In the back office, the accounts team are diligent in contracts management, invoicing and debt collection.

Ensure that your firm avoids customer and supplier concentration. Failure by a major customer or supplier could have a domino effect on your firm.

9/ Management & HR - As your business grows, your business strategies must adapt to changing operating requirements. There are increasing demands on management resources, front line and production resources, systems and technology, and cash investments.

Businesses often fail at this point when a firm does not adapt and becomes overwhelmed by the increase in business volumes and complexities.

By actively managing your business with the above steps, your business will experience more robust cash flows, which will enable your business to better withstand the difficult times which every business faces.

By having smooth operations, a firm is able to maximise profits and cash flow. Customers are happy and spread the word. Staff are happy and the culture grows.

What to Do - The Engine Room of Finance

1/ Sales Pricing - at least once a year, review your production costs and selling prices and adjust hourly charge out rates and product pricing.

Many firms are slow to raise prices and often undercharge and leave money on the table.

2/ Invoice Finance - There are a number of banks and fintechs offering immediate cash for customer invoices.

This works best where your firm is going through a growth phase - paying wages and inventory materials up front and requiring funding facilities. Usually your bank is unable to provide finance facilities (lack of property security, new business, etc).

Interest and transaction costs are partly offset by increased sales and profitability.

3/ Trade Finance - A number of banks and fintechs offer facilities to fund your inventory purchases at procurement time.

This works best where your firm buys materials for a discount on immediate payment which then offsets the interest and transaction costs on trade finance.

4/ Equipment Finance - is generally cheaper than overdraft and loan finance. Financing vehicle and equipment frees up cash for working capital - customers and suppliers.

A company I worked with went to the extreme of banking a vehicle trade in proceeds and financing the full cost of a new vehicle including GST - to maximise cash availability at growth stage. This is acceptable when your firm goes on to increase sales and profits and ultimately grow the cash holdings.

5/ Loans - Banks will lend on property securities. This is an effective way of funding grow and acquisition of property or other businesses.

6/ Overdrafts - Banks will lend on property securities and Directors guarantees. This funding usually has higher interest rates than loans and is recommended more for growing businesses.

As covered above, developing a smooth running and profitable business enables a firm to grow profits and cash flow. It is in good times that all financing facilities should be set up as banks and financiers are much more receptive to establishing credit lines and lending. This enables your business to focus on customers and grow your business.

7/ Insurance - Apart from the usual risk policies, the key business saving risks which must be covered are:

• Loss of Profits - this covers your firm should the business be out of action due to fires, floods and similar disasters.
• Employee Fidelity - Theft by employees must be covered as major theft can leave your business bankrupt.
• Trade Insurance - If you have large recurring business in a B2B market, consider getting Trade Insurance to cover customers going bankrupt.

Speak with your insurance broker to ensure that your firm is adequately covered.

SUMMARY

In normal trading, every business owner and manager must work to maximise profits and mitigate and cover risk.

Failure to build and maintain robust business profitability and cash flow leaves firms susceptible to financial shocks.

Firms must continually adapt, modify strategies, innovate and change in order to meet the changing business environment.

At the end of the day, cash rules.

"It’s not the employer who pays the wages. Employers only handle the money. It’s the customer who pays the wages" Henry Ford

Frank Choy, 3 August 2022