Tips on how to improve cash flow effectively in this crisis

As the businesses have become competitive, and global the period of working capital has got expanded. Hence, one of the top priorities for companies has been to manage cash flow effectively. Companies need to focus on managing cash flow effectively along with concentrating on profitability. Suppose the company has a choice to avail discount or defer payment. In that case, we strongly suggest that it go for the option of deferring payment as managing liquidity shall ensure that the company pays its stakeholders like Employees and suppliers on time to maintain long-term relationships with them. Cash flow management from the perspective of companies with high cash balances and increased liquidity is way different. Therefore, the management style and strategy crafting would be other than managing cash flow for small and medium-sized businesses, which works like a backbone (with generic similarities). Many small and medium-sized enterprises (including start-ups) fail because they lose the ability to pay their bills “on time,” which ultimately leads to shutting down. This “on time” cash management is the key for these small & medium-sized businesses to be competitive in the industry they operate. ??Good cash flow management can provide companies with a competitive advantage. Cash flow gets influenced by numerous factors such as type of business, the impact of foreign exchange, the industry benchmark, cash burn vs cash build rate, inventory requirements, purchase lead time, manufacturing cycle, relationship with the vendors, currency difference in sales, and purchase transactions, debt consideration, credit policies, the comparative cost of money and fixed periodic commitments. Every business situation demands a different strategy and requires in-depth analysis & review before employing any procedure; here are some tips that can help improve a business’s cash flow.

1)????PLAN -Prepare, measure, compare & frequently update forecast: Managers must plan the cash flow. Managers should carefully write the cash flow plan, including what-if scenarios, like other written policies and procedures. A simple forecast is a concept of the past; due to the highly dynamic business environment, the cash flow forecast is updated on an ongoing basis to transform it into a competitive advantage over other similar companies. Yearly, semi-annually, and monthly cash flow forecasts are good starting points to arrive at a baseline. However, for small to medium-sized businesses, a weekly forecast with constant updates (to reflect changes based on business requirements) could yield excellent results improving the overall cash flow. Cash flow is monitored daily, and its position at least every week.

?2)????Make it easy for your customers to pay: You will not get paid on time if you make it easy for your customer to pay you. Simply, the more time or steps it involves completing a payment transaction, the more payment delays you will observe. Accept debit card, credit card, PayPal, visa card, master card, American Express, cheques, cash and use any other payment platform to make it easier for the customers to make a payment which involves fewer steps and minimal time which will help your customer to reduce the “cost” of making a payment. It is essential in industries such as construction, wherein many supporting documents need to be submitted along with invoices as per terms and conditions of the contract to give proof on % of work done and seek approval on the invoice. Often, the payments get delayed not because the customer does not intend to pay on time but because getting the invoice approved is incorrect. Similarly, in the workforce supply industry, the invoice is raised based on workforce supplied and rate depending upon whether this workforce has worked in a regular shift or beyond standard change or in night shift wherein the rates are higher than regular shift. ?

?3)????The “payment vs receipt terms”: Running a business with shorter average vendor payment terms than longer terms for customer receipts is a perfect recipe for disaster. The first thing to do in this scenario is to stop this “terms deficit.” One should look at various factors; however, the goal is to get paid early and stretch the payment terms as much as possible. “How” is a matter of subjectivity, and there are many methods managers can use. It is achieved by deploying various tactical strategies, e.g., such as differentiating the product from the competition, delivering the best quality, marketing the product using an ROI-based approach, or simply offering an early payment discount. The idea is to do something that your customers feel good about when paying you early when comparing you with their other vendors. Examples of obtaining longer payment terms from the vendors include building up credibility, making sure to pay by the agreed-upon terms…. yes “without delays,” showing the vendor that payment is a decisive factor of your vendor approval process (provided a competitive industry), without compromising on the quality of the product – work with the vendors who want to grow in the industry, etc. The more a vendor can penetrate the industry, the more flexibility it might offer its customers to increase sales. If your product can outcompete the competition, use a “partial payment in advance” term to sell to the customers. This might not fit all the products offered by your business, but you can always use it for the segment of products that have such a competitive advantage over competitors.

4)????Purchase commitments: This is another critical area to analyze and make sure that it is well synced with your sales in the funnel with a greater degree of certainty. Often small- medium-sized businesses are at the mercy of their vendor with more negotiation powers due to their size and influence in the industry. The real challenge is when vendors require companies to place the orders months in advance to streamline their supply chain and achieve their yearly sales target with little to no room for changes. A good strategy is to shorten this gap with the eventual goal of maintaining the optimal inventory balance (only if required). Reducing the lead time to receive inventory can help release the funds locked in-stock storage and improve the cash flow. Another practical aspect noticed is to keep close control of the inventory receiving and to count the payment terms when the product has been accepted (make sure to draft it in the purchase agreement clearly). When negotiating a purchase agreement, insert the clause that allows you to update purchase orders (delivery dates, quantities, and other flexibilities) when ordering in advance.

?5)????Study the working capital cycle: It is essential to study the working cycle from procurement to pay, i.e., the point at which the company invests funds to secure raw material stock until payments are received from the sale of FG to customers. Each component of working capital should study in-depth to understand the number of days for which working capital is getting a block for that component. For example, after the raw material is procured, how much time is taken to take the sample out of it for quality testing, how much time is taken to send it to the production dept for processing, what is the time taken to convert Raw material into finished goods and then for what time it is stocked before supplying the same to the customer and then how much time customer is taking to make payment. The study of this circle helps to reduce the cycle and thereby unlock some cash into the system. In the manufacturing industry, usually, this cycle is long. In the retail industry, this cycle is negative if the goods are procured locally from suppliers on credit but are sold on a cash basis to retail customers. New purchases are made only when the existing stock is sold in this arrangement, so funds are not blocked in inventory.

?6) Other factors to consider: Regardless of the industry-specific factors, some strategies are generally accepted across multiple industries, resulting in the overall improvement in the cash flow. Following are some of those methods which you can also implement to achieve better cash flows.

a) Get Overdraft (LOC)-Line of Credit from the bank and use it to the minimal (only if required!):?Couple other factors like investment yield rate Vs. The cost of borrowing the money etc., will come into play; however, generally, LOC with lower interest rates from the banks is an excellent way to meet temporary cash requirements.

b) Factor your AR balance:?This is a great strategy when dealing with customers with good credit ratings. However, to have this effect and work for your organization, one needs to ensure that the company has a good credit check control/policy when accepting new customers. Some key factors that help evaluate the creditworthiness of the potential customers include asking for references, analyzing credit reports (D&B, Equifax, etc.), looking at the financial data and historical payment data, etc.

c) Reduce overheads! to reduce the cash outflow:?This is an ongoing strategy, and managers should constantly investigate ways to cut the OH whenever they have an opportunity. It is more of an overall inbuilt system and should always be considered by the company. It must be filtered down from leaders (on the top) to the managers and employees (who are involved in the daily decision-making process).

d) Create a reserve:?A good cash flow management approach is constantly working with a buffer. Instead of using the total available limit when considering operational payments commitments, limit it to a level and invest the portion of the surplus. Always use a reduced threshold as opening balance and use the cut portion as a reserve account or for other investment purposes.

e) Communicate!!!! The approach to the employees:?It is integral for a successful plan to communicate well to all stakeholders, especially in an organizational setting. A well-crafted strategy can fail because of poor communication or a lack of understanding among the participants. Similarly, good cash savvy communication and philosophy are essential so that each employee at their level understand the bigger picture and understand how their portion will fit in an overall winning strategy; besides cash saving, this will also result in everyone taking pride in the overall success and will increase the motivation level as well among the employees.

?f) Issuing Retention bond for recovering retention receivables: In many industries, including the contracting industry, the client retains 5 to 10% of the contract value as retention and can be paid only after 15 months or up to 36 months after the completion of work depending on the terms of the contract.?These receivables can be encashed by requesting the bank issue a retention bond instead of receivables, improving the cash flow.

?Various other kinds of financing from the bank by which cash flow can be improved although at the cost of paying interest are as follows:

?1)???Cheque discounting: ?Payment terms with customers should be negotiated as post-dated cheques (PDC). Hence cheque discounting facility can be set up with the bank wherein the bank finances the transaction and pays now to the company, and payment is recovered on the due date of PDC. By this arrangement, the customer gets a credit period to make the payment, but at the same time, the company can get paid now through bank financing.

?2)???TR- Treasury Receipt: TR is the instrument issued by the bank for a financing purchase transaction of goods for purchases made wherein the payment needs to be made immediately to the supplier. For this purpose, the bank requires the supplier’s invoice, Trade license copy, and proof of delivery.?This financing can be extended to services as well by obtaining special approval from the bank.

?3)???Pre-shipment and Post-Shipment Financing: In case of manufacturing or trading concerns producing or procuring goods to export bank financing in the form of pre-shipment funding is possible if confirmed export order can be shown to the bank. Similarly, the manufacturer can get financing post-delivery of shipment as well.

?4)???Project-based financing: Banks do finance to Contractors and Sub-contractors, which are project-driven. Hence funding is restricted to the financing activities relating to the project only.

?5)???Vehicle / Equipment Financing: This type of financing is done not only by banks but only by non-banking finance companies for CAPEX purchases.

?6) Business Loans: These types of loans are given to fund the temporary gap in the working capital. However, the rate of interest charged is very high for this type of loan.

?7)???Term Loan: To fund the fixed assets, banks offer financing in the form of term loans. The tenure of a term loan usually is four years. Please note that as per the bank’s sanctioned terms and conditions, the funds financed through term loans can be used only for building or purchasing the fixed asset.

?8)???Loan against margins or Fixed Deposits: If fixed deposits or margins are given to banks for some purpose, it is possible to get bank financing up to 90% against that margin or fixed deposit subject to terms and conditions of banks.

?9)???Overdraft facility: Banks provide cash in an Overdraft facility to fill in the working capital gap.

?10) Corporate Credit Card: Banks issue corporate credit cards through which the company can get credit for up to 60 days for utility bills, fuels, etc.

Cash flow is the lifeline of the business. Hence, it is prudent that the owners not withdraw the total profits but plough back part of the cash profit to manage liquidity easily during rainy days, such as when Coronavirus has created a business crisis. It is essential while reviewing gains as per P&L; management also reviews as to what is its free cash flow as ultimately liquidity shall be managed with that cash flow. Working capital management report gives the idea to management as to where its funds are blocked.

The recent crisis shall teach us a lesson on how to manage cash flow effectively.

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