Business cash flow

One of the first things to understand is that profits generally don’t automatically equal cash.
For example:

• Let’s say you’ve made a $30,000 sale
• Your operating expenses represent 10% –$3,000
• The cost of stock to your business is 50% –$15,000
• So that’s $12,000 profit

For the sake of this example, let’s now assume you offer your customers 30 days’ credit. The customer pays a 10% deposit ($3,000) on receipt of the goods and will pay the final $27,000 in 30 days. However, you’ve paid for the stock and operating expenses up front.

For example:

• Funds collected from the customer $3,000
• Stock and operating cost to you –$3,000
• Cash flow shortfall –$15,000
• You’ve got a cash flow shortfall of $15,000 to carry for the next 30 days.

What happens if you make two more sales? On paper you’d have profits of $36,000 (3 x $12,000). You’d also have a cash flow shortfall of $45,000 (3 x $15,000).

So what do you do about this?  Understanding your operating cycle and planning your cash flow accordingly is critical.

Getting a sense of your operating cycle is relatively straightforward. First, leave all the other reasons for being in business to one side and look at the end result solely as cash.

Track the times when cash moves in and out and how part of this cash is reinvested throughout the full operating cycle and then continues.

The length of the operating cycle is the key to understanding how much cash a business must have on hand (or have access to). The shorter the cycle, the fewer cash reserves required.

Running short of cash at any stage of the cycle could cause problems. In the example we previously used, if you are waiting on debtors and can’t purchase materials, manufacturing could be delayed. If the delay is significant, you could run out of stock. The result will be a shortfall in sales, which in turn leads to less cash coming in, causing another delay in the purchase of materials, and a further delay in manufacturing. This cycle can quickly spiral out of control.

Cash flow forecasting is usually completed over a 12 month period (matching your business planning year) on a monthly basis. To maintain focus on the bigger picture ensure the forecast has a system for keeping track of the cumulative figures.

For further information you should go to The Small Business Hub where you can download a cash flow forecast template.

Cash flow management isn’t just about the movement of cash in and out of the business. It’s also about ensuring there are sufficient funds to pay wages, suppliers, taxes and expenses when they fall due. It’s important that you forecast for your monthly cash needs on a regular basis, then compare your forecast with the actual results and adjust the forecasts accordingly.

Here are some options to help improve your cash flow.

Option 1 – Shorten the operating cycle
One way to attack cash flow problems is to shorten your operating cycle. Look at the individual components and see which ones can become more efficient. The most obvious is to collect debts sooner.

Option 2 – Remember there is an opportunity cost to trade debtors
That is people to whom you have supplied goods or services who owe you money. The money tied up with trade debtors belongs to your business. It could be much more productively invested elsewhere and, if you’re operating an overdraft, trade debtors may also cost you interest.

Option 3 – Collecting debt
Be clear about your payment terms up front to ensure there’s no misunderstanding. Consider offering incentives to pay early.

Option 5 – Progress payments
Look at making or receiving payments at different stages of your operating cycle. This works by arranging for a certain level of funds to be paid prior to the job, further funds released during the work and the remainder paid on completion.

Option 6 – Ex-factory sales
If you’re a manufacturer and you deliver to retailers on consignment or a mixture of consignment and COD or Payment at terms, then to raise immediate cash you may decide to hold a direct from the factory sale.  But you need to be careful this doesn’t damage your relationship with retailers who currently stock your product.

Option 7 – Leasing
Leasing equipment instead of purchasing can free up cash.

Option 8 – Cash Discounts
Providing discounts for cash purchases can improve cash flow but you may also find yourself offering discounts to customers who would have paid on time anyway and in the end you make less profit.

Option 9 – Extend the trading terms with your suppliers
A way to improve your operational cash flow is to take longer to pay your suppliers, or take stock on consignment.

If you need finance there are a number of options which may be available. Consider what type of finance you need.

Short-term finance is used to maintain cash flow by purchasing assets that will turn over quickly. You’d expect that this borrowing will be self-liquidating, meaning the moment the cash is received from the debtor, or when the goods are sold, the loan will be repaid in full.

Short-term finance includes
• Overdrafts
• Business credit cards
• Import finance

Find out more about short-term finance or talk to a Small Business Specialist.

Long-term finance could be used for the purchase of the business itself, acquiring a new business or acquiring other fixed assets such as plant and equipment.

Releasing equity to new owners is another option but taking on partners and releasing equity in a business you have built is not easy. Make sure your new partners bring much more than finance to the table.

Venture capital is where you surrender a proportion of the ownership of your business in return for funding. However, when raising venture capital, it’s vital to understand exactly how much of the business you’re surrendering and what level of influence the investors will have on the day-to-day running of the business.

The type of finance you choose will depend on your individual needs and the circumstances of the business. Things to consider include:

• Why do you need finance?
• Is there another way of proceeding without taking a loan?
• What will be used as security?
• Do you need to use your home or other personal assets to secure the loan?
• Do you have a plan for how and when the money will be repaid?

Managing your cash flow is key to business success and if you are applying for finance it helps to deal with an organisation that understands your needs.

An ANZ Small Business Specialist - Can help you by reviewing your business’ financial situation and recommending solutions to help maximise your cash flow.  Why not book in an appointment for an A-Z Review^® to tailor a solution for your needs? Speak to your local ANZ Small Business Specialist today.

Our Small Business Specialist can also talk to you about the following short and long term finance solutions:

ANZ Business One Visa - Earn rewards on your everyday business credit card purchases.
ANZ Business Overdraft – To help you with short-term cash flow issues and provide working capital of $2,000 or more.
An ANZ Business Loan – To give you the capital you need with loan amounts of $10,000 or more.

The Small Business Hub  - Provides you with valuable information and advice about managing and improving your cash flow. Plus, free access to hundreds of articles, downloadable guides, templates and advice from industry experts to help your business succeed. Visit The Small Business Hub.

Xero – An easy to use, online accounting system that provides real-time data, and helps you stay on top of your cash flow. Find out more about Xero.

ANZ Business Insights – Provides retail businesses with access to invaluable information about your customers and the performance of your business compared to local industry. Visit ANZ Business Insights.