If you are managing your cash flow by looking at your bank balance every day or from “back of the envelope” estimations, you may be courting some sleepless nights.
Not making payroll, IRD, bank and key supplier payments is every business’s nightmare. There is only one reason this happens – the business just ran out of cash. Never forget that cash is king.
Here are five common cash management mistakes and how to avoid them
Mistake No 1: No cash flow reporting and forecasting systems
Every business should have at least a rolling 12-month (2+ years is ideal) cash flow forecast. But if cash is particularly tight, a 13-week cash flow forecast would be recoommended.
The 12-month forecast will indicate what funding the company needs to arrange for its working capital and long-term growth requirements. This should be updated monthly. A 13-week forecast will flag any near-term cash flow constraints that need to be managed. It will also prompt action to accelerate cash flow, secure temporary funding and defer discretionary spending to avoid a cash crunch.
There are a range of cloud-based cash flow forecasting tools now available that will suit many simpler businesses. With software such as Futrli, automatic updating from Xero and MYOB will get you out of Excel hell. But if you have a complex business, the experts like us still use Excel.
Mistake No 2: Not managing working capital
Working capital comprises inventory, work in progress, receivables and payables. As a business grows the amount of cash tied up in these items grows.
The less a business has tied up in working capital the greater will be its operating cash flow. Key to this is close management of receivables, optimising inventory, reducing slow moving items and minimising work in progress by ensuring high throughput.
Funding working capital is important. The first option is to get favourable payment terms from suppliers. For an established business, there are many options available to fund working capital from traditional banking facilities. Also consider non-banking funding options – debtor finance, trade finance for imports and tax pooling for provisional tax payments. There is also unsecured business funding available from non-banks.
Mistake No 3: Confusing profit with cash flow
Many business owners are confounded when they have made a profit for the year and have tax to pay but the bank balance at the end of the year is lower than it was at the start of the year.
There several factors that lead to differences between profit and cash flow. These are increases in working capital, capital expenditure, loan repayments and shareholder drawings and dividends.
One of the most common mistakes is funding capital expenditure from operating cash flow or working capital facilities. Longer term funding is more appropriate (loan or lease) for capital expenditure items.
Mistake No. 4: Not managing margins and overheads
If your business is at breakeven profit or making a loss there will constantly be cash flow challenges. There will be no operating cash flow to fund any increases in working capital, loan repayments and shareholder drawings.
A business should be reviewing monthly opportunities for more sales, fixing underperforming margins and keeping a constant watch on productivity and discretionary overheads.
A great place to get a handle on what good performance looks like for your industry is to obtain industry benchmarks by talking to your accountant, business advisor and industry contacts.
Mistake No. 5: DIY Financial management
For many SMEs, it’s unlikely they can afford to hire the expertise that is required to address the areas above on a full-time basis. In larger organisations, these duties are performed by Chief Financial Officers (CFOs).
In recent years, SMEs across the world are embracing the new concept of virtual CFOs. Benefit by getting a high level of skills and strategic advice on an as-required basis. Typically, this may be a few hours a month through to one day a month.
A good virtual CFO will improve your business performance by boosting profitability, cash flow and the value of your business. This allows you to spend less time in the business with a clear exit strategy when the time comes.
Contact us today for a free, no obligation appointment to see how a Virtual CFO could make your business more profitable