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Improve your cash flow

A common complaint of business owners is that there is not enough cash to pay wages and keep creditors happy. There are some simple cash flow tips and measurement tools that you can use to keep your cash flow moving.

Plan ahead

Keeping a simple cash flow budget enables you to know what is coming up and plan accordingly. For example, by knowing what is coming up, you can then make an informed decision to delay a payment to a non-critical supplier to accommodate a quarterly BAS payment. Alternatively you might decide to phone your bank manager to get a temporary overdraft to get around a short term problem. However if you don’t know about the problem until the BAS is due to be paid, you may not have the funds available.

We have a number of simple cash flow budget tools than can be sent to you. Alternatively a budget can easily be drafted using a spreadsheet. The starting point should be what cash you have now, what is coming in and what needs to go out.

Set payment terms

Have a credit policy and stick to it! Buying on credit is a privilege extended to worthy applicants and should not be available to everyone. Start customers with a low limit and extend it when they have proved worthy. If they pay you outside your credit terms, be prepared to stop supplying. Remember that if you work on a 5% net margin, you need to have $100,000 more sales to cover one $5,000 bad debt.

Make your payment terms clear

Communicate your payment terms clearly to customers and print them on your invoices. Follow up customers quickly when they fall outside these terms, otherwise they might assume that you don’t mind being paid after 90 days.

Consider having contract terms that allow for interest and debt collection costs to be passed on to the customer. Also, take the time to check a customer’s credit history; new customers might be dealing with you because no-one else will sell to them.

Measurement of debtors

Keeping an eye on your debtor days, is a simple way monitor how much cash is tied up in money owed to your business. Debtor days is calculated as follows:

$ Debtors / Sales per day.

For example if a business has sales of $1,000,000 and debtors are $90,000, the debtor days are:

$90,000 divided by [$1,000,000 /365 ] =
$90,000 divided by Sales per day $2,739 =
32 days tied up in debtors.

If the business had trading terms of 30 days, this would be an acceptable outcome. Most businesses that have credit sales have debtor days in the 30 to 60 day range.

We recommend monitoring this ratio over a period of time to observe any trends in the debtor balance.

Keeping your staff informed

Sales staff need to see the big picture. Keep them informed about customers who are outside their credit terms. Then they won’t waste time and energy on them and continue to sell to them when they shouldn’t. Good sales margins can be negated by bad debts and poor cash flow.

This information also needs to be current. We recommend that you update your debtors lists at least weekly.

Reconcile what is being paid with what is owed

Customers often pay less than the invoice or statement amount. These short payments need to be followed up quickly and the issue resolved. An accounts receivable person will often apply the payment to the oldest balance in the receivables ledger, which masks the true situation. Take the time to apply the payment against the invoices being paid and if in doubt seek more information from the payer. If payments are not reconciled at the time of payment, the unreconciled amounts won’t go away. These amounts are likely to lead to a dispute with the customer some time later and possibly will need to be written off in your books.

Accept electronic payments

To avoid customers using the ‘cheque in the mail’ excuse, print your bank account details on the invoice. Also consider BPay or credit card facilities as an alternative receipts method.

Delay payments

Prioritise your payments into order of urgency. Those that have the greatest consequences come first: interest bearing debt, payments to avoid penalties and payments that are critical to operations.

The next in order of urgency are your normal suppliers. In this category those that are most proactive usually come first. Pay those that scream the loudest.

Those that are last are one -off suppliers, discretionary expenses, discretionary owner drawings and suppliers who don’t chase outstanding debts.

A supplier who needs your business may offer extended terms and you should take advantage of these where possible. For example a small local distributor may have a slightly higher price, but could offer 90 day terms for a large order, whereas a national distributor has strict 30 day terms and may not miss your custom.

To measure the effectiveness of delaying creditors, the creditor days calculation can be useful:

$ Creditors / Purchases per day

For example if a business spends annually $800,000 and creditors are $60,000, the creditor days are:

$60,000 divided by [$800,000 /365 ] =
$60,000 divided by Purchases per day $2,191 =
27 days of creditors outstanding.

In the above example, 27 days of creditors would indicate that supplier terms are not being fully utilised. Commonly creditor days are around 45 to 60 days. If creditor days are over 60 this implies that on average payments are one month later than 30 day supply terms.

Manage your cash

Cash should not be left indefinitely in a non-interest bearing cheque account. Check with your bank to see if a cash management account can be linked to the main business account. Use it for excess day to day cash and bring cash back to the operating account where necessary.

Manage your leave liabilities

Keep a track of the leave liabilities for your business. It is essential to fully manage the cost of your employees. Remember, employee liabilities won’t go away. They are either paid in the ordinary course of business, paid on termination or adjusted when the business is sold.

Once you know the liabilities, you can manage the cash flow impact. It is usually better for leave to be taken annually in manageable amounts rather than to let the employee accumulate large amounts of untaken leave.

Remember that every increase in an employee’s pay has an impact on leave liability. For example if an employee is owed ten weeks of leave at the time of receiving a pay rise, not only is the higher rate paid for the normal pay, but the higher amount is paid on the 10 weeks of outstanding leave.

Control your stock

One of the largest investments a company makes is in its stock on hand. It is often in excess of what you need to hold.

Firstly work out the number of days stock you have on hand. This is worked out simply by using this formula:

$ amount of stock on hand / Daily cost of sales

For example, if a business has stock on hand of $1,000,000 and has annual cost of sales of $8,000,000, the number of days stock on hand is:

$1,000,000 divided by [$8,000,000 /365 ] =
$1,000,000 divided by Daily cost of sales $21,917 =
45 days stock on hand.

You should aim to reduce your days stock on hand to the point where you have just enough to avoid running out. The number of days of stock on hand will vary between industries, but the general rule is that less days is better.

By knowing how long it takes from the point of ordering to the point of delivery, it is possible to re-order stock so that you keep only the minimum amounts without running out.
You should also question whether you need to hold stock of some items at all. If it is possible for stock to be delivered from the supplier direct to the customer, there is often no need for the stock to be held by you.

Obsolete stock or perishable stock that is approaching its use by date should be sold for whatever you can get for it. You may need to take a loss on some stock, but its value is unlikely to increase and it is better being turned into cash.

Sell excess assets

Assets that are not being used are tying up cash and occupying space. These should be sold for whatever they can realise. Remember that their value is unlikely to increase, so holding assets ‘just in case’ is a false economy.

If large capital assets are required in your business, these could be used in a ‘sale and leaseback’ arrangement. This frees up the asset’s capital and provides a form of finance which can then be used elsewhere in the business.

You should also consider renting some assets rather than buying. Assets with high risk of obsolescence (for example photocopiers) can be rented and returned when obsolete. If purchased, this sort of item ties up cash and the purchaser carries the risk of obsolescence.

Finally, if you have continual cash flow shortages, it is likely that the business is not performing as it should and some fundamental changes need to be made to the business model. If you suspect this is the case, we suggest you contact Saward Dawson for advice.

Daniel Turcato

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