Very first the basics – some would say the obvious – the fundamental requirement in keeping a business alive is cash. Not really customers, and not profit – you could have both of those things and still possess a business failure. Cash is like the lifeblood of a business. That’s why the particular maxim, “Cash in King” is really true.
Anyone in business should have noticed this. But it may still appear confusing to you how you can be lucrative and run out of cash and fail. If that’s the case then you can think a lot more clearly about this by remembering 1 word – timing.
Take a very easy example – I buy a car for £5, 000 and sell this for £10, 000. There is no query that I have a good customer and am have made a profit. But if I have to purchase the car tomorrow, and I am never going to get money from the customer until next week, then my business will fail if I don’t have £5, 1000 cash to pay for the car tomorrow.
The basics of cash flow management, really, are that to maintain the level of cash required to survive (zero, or perhaps less for those who have an overdraft facility) you must have a lot more cash coming in than going out.
Sometimes the business is so consistently loss-making it requires constant propping up by lenders and investors.
Cash venturing out is more than sales receipts arriving, so more and more capital is required to ensure that the cash does not run out.
I individuals one such small business. The thing that amazed myself at the time was that even after the last great deal of capital had been used up, even though each month’s accounts showed a reduction, and even with no overdraft facility, the company managed to continue two months longer than anyone thought possible… and long enough to allow a rescue.
How did we do that? I think there were three key things that we did (apart from the obvious cost control actions that were necessary):
First, we created cash flow forecasts in detail every week. The particular forecasts went forward 6 months — weekly for the first 3 months, after that monthly after that. The base forecast detail was based on the same assumptions as the profit and loss forecast and went to quite a low level of detail. It showed very clearly when the shortage of cash would happen, how long it would last and how large the shortfall would be.
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To get a really feel for the level of detail, on the revenue side we forecasted three types – i) receipts from borrowers (i. e. cash for invoices already raised, based on payment conditions and specific knowledge of each customer); ii) receipts from customers upon projects not yet started, however the work has been ordered (i. e. so we know roughly when we needs to be invoicing for the work, how much and how long it will take to collect the cash); iii) receipts from deals in the sales pipeline and therefore may or even may not come to fruition (i. electronic. there have to be probability judgments around which proposals will be successful, what the agreed prices will be, what invoicing timing will be agreed, and when the particular projects will start).
On the expenses side we forecasted different types of costs depending on its materiality and timing. Salaries, bonuses and commissions were monthly and fairly predictable. Rent was payable quarterly. PAYE and VAT also had a predictable design. Loan interest payments were set. Then staff expenses and other invoice payments were the variable elements. We knew from the profit plus loss forecast and budget, when compared to actual P&L for the previous yr, what a reasonable assumption of monthly expenditure would be. We adjusted to get VAT / GST, and we knew that we could flex the time and size of the payment operates to a certain extent.
Second, we relentlessly monitored the bank account and the debtor checklist. The CFO would get copies of the bank transaction print-outs every day plus check against what we forecasted. If customers did not pay when they had been expected to, we would chase the task managers and customer account company directors as soon as the invoices became overdue. Due to that we got to the point where we had just a handful of invoices overdue for collection from customers.
Thirdly, we understood what payments we could flex and for that reason what our limitations were on payment runs. The extent to which we had cash to pay suppliers has been determined by whether the inflows came in not surprisingly. We knew we could flex PAYE payments by a few weeks, but there was a limit. And we knew that to keep the business going we had to keep paying the payroll, keep paying out the loan interest, keep spending the suppliers. But we furthermore knew that unless we began to make a profit we had to be careful with all the timing of those payments, and so there were a fairly tense few months when we only just stayed on the right side associated with some of our key suppliers.
Results: Accelerate the inflow and decelerate the outflow and you can make the money go a lot further. Also, with careful, detailed monitoring and predicting you can see a lot more accurately exactly when you need the rescuer to come in, when the investors need to increase their contribution, or even (heaven forbid) you need to call the administrators.
That’s putting it negatively, but it applies positively as well making surplus cash is not just a protection cushion. Surplus cash allows you to spend money on the future without having to ask for extra expense from shareholders or ask for a lot more borrowing. It also allows you to pay larger dividends to the shareholders. Knowing how huge the surplus will be and when it will happen will help to plan investments or dividends or the like.