A well managed cash flow solution keeps the business healthy and will not be a cause that inhibits the company’s growth. Poor cash flow management can really destroy an otherwise thriving business. In this article, we will provide a high level understanding of the importance cash flow and cash flow solution, and tips on how to avoid cash flow issues.
Cash flow Solution: Overview
As an analogy, cash is like water in a tank. The water level in tank represents the cash the business has i.e. working capital. Water flows in and out of the tank. When the outflow is greater the inflow the water level in tank falls. If situation persist then the water level continue to fall until the tank is empty. An empty tank is like zero cash for the business i.e. zero working capital.
Cash Flow Solution : Tips on avoiding cash flow problems
1. Poor pricing model
If the business does not have sufficient sales margin, it is only a matter of time that cash flow issues will emerge. If not proactively managed, this can be very detrimental to the company. Businesses should ensure that the set out sales margin will adequately cover the sales margin.
- Cost of goods sold, being the actual physical goods / inventory
- Operating expenses, including (but not limited to)
- Product return / defaults
- Financing costs
- Cost of credit term (i.e. how much does it cost if you give out 30 days credit term)
- Contingency matters, e.g. legal, bad debt, uncontrollable events
One cash flow solution tip is that sales margin should at least cover the above plus extra to make a profit for the company. Otherwise, the business will be bleeding cash and as the company continues its operation, it will eventually use up all its available cash.
2. Rapid growth / Sales is too low
Achieving business growth is what every SMEs are thriving for. However, if the pace is too rapid it can have adverse effect on cash flow. In order to fulfil the growing orders, the SMEs will have to dig deep into its cash reserve or working capital to cover the upfront costs.
For these particular cash flow issues, the cash flow solution would be to ensure that appropriate financial are put in place. Bank overdraft, credit line facilities, bank loan or invoice financing are some available options that will ease the cash flow requirements and allow business to grow.
On the other hand, if there is not enough sales, there will be low inflow of cash. But outflows will continue for fixed costs items like rental, salaries and wages and will over time quickly deplete the cash available. Sales and marketing strategies must be reassessed to boost sales.
3. Supplier / Customer unmatched Credit terms
Unmatched credit terms is when the business has given credit terms to its customers that are longer than its own supplier’s credit term. For example, your business may pay its suppliers on 30 days term but can only collect payments from its customers 60 days after delivery.
This will surely result in negative cash flow, where business is paying out faster than receiving the cash in from its customers (i.e. cash outflow is faster than cash inflow).
To tackle this issue, there are a couple of actions that can be carried out:
- Re-negotiate your credit term. Read more here
- Opt for invoice finance to shorten accounts receivable / DSO (Day Sales Outstanding). Read more here
- Set up a line of credit
4. Difficulty to forecast cash flow
Not knowing clearly when cash is needed and when cash in coming in puts the business in a very vulnerable state. It will limit the business ability to make prudent business decisions and can ultimately cause cash flow issues. Hence it is essential for businesses to regularly review their Sales and Operation Plans (SOP) to ensure efficient use of funds.
Read more on forecasting cash flow solution here.
5. Poor inventory management
Business inability to manage inventory effectively is a very common and key factor resulting in cash flow issues as well as cash not being put into more productive activities in generating sales revenue. Some of the examples of poor inventory management are:
- High inventories of raw materials i.e. holding too much raw materials
- High inventories of Finished goods – overproducing finished goods
One cash flow solution to mitigate this is to use ready available softwares, which can help SMEs better plan inventory, namely tradegecko.
6. Poor Debtor and Credit Management
Not taking proactive steps to make collections for overdue payments or worse when the business has no mechanism to alert management on overdue payments. This will again bring down the business cash reserves.
More significant such businesses will fail to continuously reassess its customer credit rating thus could be unknowingly extending credit to a bad and risky customer leading to some very large bad debt that can ruin an otherwise successful and profitable business.
In this scenario, it might be worthwhile for business to hire an accountant/finance who can lend expertise and provide the ideal cash flow solution.