Managing cash flow.

Hello, I’m Rob Lockhart from Westpac’s Davidson Institute, here to talk to you today about ‘Managing cash flow'.

Someone once said to me “Profit is just a matter of opinion. It is something your accountant puts together for you for tax purposes”. Whereas cash is real. Cash is king. Cash is the lifeblood of your business. To ensure that the lifeblood continues to pump through your business you need to understand what cash flow is and how to keep it flowing

To understand the lifeblood of your business, you need to first understand “What is cash flow?” then, where you can find cash hiding in your business and use that information to improve your cash flow. Cash flow might be simply the money going in and out of your business, but it is vital to the continued operation of your business. You may be able to operate without profit for a while, but you cannot operate without cash.

To begin understanding your cash flow it helps to understand what is going in and out of your bank account. You can do this by putting together a snapshot of your cash position.

Start by identifying your cash inflows. The majority of your cash will be received from making cash sales. However, some of your customers may be on account. That means, instead of receiving cash you gave them an invoice to pay you sometime in the future. These are known as debtors or accounts receivable. You may have some other income, such as interest or dividend income, or maybe subsidies or grants. This also needs to be included.

Once you have your inflows, you need to identify your cash outflows. These will include payments to your suppliers who are also known as creditors or accounts payable. Record all your general expenses such as rent, electricity, accounting fees and all your overheads. If you have employees include their wages and salaries. If you have borrowings include interest and principal repayments. Don’t forget the other expenses you have, particularly the ones that happen infrequently like paying GST, Tax,

PAYG, Super and Insurance. Now take away your outflows from your inflows to give you your ending cash position. Once you have your ending cash position, you will have 1 of three results.

Firstly, a positive cash flow. If you consistently have positive cash flow this gives you opportunities. You can opt to spend it now to take advantage of a current opportunity; you could save the cash to pay future bills or cover future negative cash flows; or you could invest the money into growing your business.

Secondly, a neutral cash flow. A neutral cash flow means you do not have to find any more money to fund your business, but it also means your opportunities to spend, save or invest are limited.

Thirdly, a negative cash flow. Now don’t panic just yet! It may only be a short-term problem. This does not mean there is anything wrong with your business. All it means is you need to find the cash to cover it. You might get the cash from your own pocket; you may take on a partner who injects cash or you may need to come to borrow the money.

The information you gather for your cash position will help you to put together a cash flow budget for your business. A cash flow budget is one of the most useful tools to understand and manage the cash in your business. It’s a good idea to do a cash budget at least monthly. You can do it more often if you want.

You start out with your beginning cash. That is the cash in your bank account. You add to it all the cash you expect to come into your bank account that month from cash sales, debtor collections and any other cash you think you may receive. You’ll need to factor in timings such as how regularly your debtors pay you. Is that in the same month as you invoice, or how long after?

Adding your beginning cash to the cash you expect to receive will let you know how much cash you have available to pay for your outflows. You then need to record how much you think you will pay out each month, to your suppliers, which are also known as your creditors. Include all your general expenses like rent, advertising, consumables, cleaning & maintenance and so on. Don’t Forget GST and Tax payable with your BAS statement and things like Insurance which may only be paid once a year.

If you employee people, you will need to include wages and salaries. Don’t forget PAYG payments and super. Also include any debt repayments including principal repayments, interest and leases. And any other payments you may make such as dividends or owner’s drawings.

Once you have completed your cash budget you can then decide the best ways to treat positive, neutral or negative cash flow positions. Now that we understand the basis of cash in and cash out, we now need to understand a little more about the timing of cash flow and where the cash tends to pool or hide in your business.

A great way to understand where cash hides in your business is a concept called the Working Capital Cycle. Every business has a Working Capital Cycle, but they are not all the same. I am going to start out with a generic Working Capital Cycle and then I’ll talk about some variations.

You start off with the money or cash sitting in your bank account. Now your money sitting in your bank account is no good to you. You want to use that cash to make profits. To do this you first need to buy something that you can sell. In this case you are going to take the cash out of the bank account and go and buy some stock. Then you look to sell that stock as quickly as possible as this is now cash tied up that you cannot use for other purposes.

For some of you when you sell your stock you get your cash straight away either as cash or as credit cards for others though you sell on credit. You issue invoices and end up with things called debtors or accounts receivable. This is where you are essentially lending your customers the money to buy your goods or services. Then you wait for your debtors to pay you and eventually the $ comes back into the business, hopefully with some profit too.

The reason we are interested in this cycle is because cash flow is dependent on how long it takes for your $ to go all the way around the cycle. The faster you turn the cycle, the more cash you will have available to you; allowing you to grow more rapidly, reduce the risk and cost of using short-term debt, and potentially improve your profitability.

I said at the start of this not all businesses are the same. 07.56 The retailers out there are looking at this and saying, I get everything in cash and credit cards I don’t have debtors. You ‘re absolutely right. Your cycle just goes from cash in the bank to stock and back into cash. That’s a bit simpler, however the biggest killer of retailers no matter where you go in the world is poor management of stock. With lots of cash tied up in the stock on the floor, how are you going to pay the bills?

You’ve got to turn your stock and make sure your cash is working for you. Others of you are saying, “Well hold on a second, I’m a service business. I don’t have stock”. And again, of course you’re right, however you have something that acts a little bit like stock it’s called work in progress or WIP. Basically, you take on a job from a customer you do all the work for them, then you send out an invoice.

While you are doing all that work, before you can send out the invoice, you still need to pay wages, rent, utilities and so on which is using up your cash. Then you send out an invoice and wait for your customer to pay you … more time before your dollar comes back into the business.

Whatever business you’re in, you have a Working Capital Cycle. There are of course other variations too, but it is important to understand how the cash flows through your business, so you can find where your cash is hiding, and speed up your Working Capital Cycle.

We now know how your cash flows and that if your Working Capital Cycle slows down, it can cause your cash to pool or hide instead of flowing. Now we need to work out how to get your cash flowing again. To do this we will look at each element of the working capital cycle, Stock, Work in Progress, and Debtors, and the actions you can take to improve cash flow.

A very common place that cash can hide in your business is in Stock so let’s start there. The stock pool is a brainstorming tool to help you identify where you may be able to free up cash. The stock pool is basically like a big swimming pool where all your Stock is sitting. To fill up this swimming pool with Stock you need to purchase it. I’ve got purchases coming in, and it’s filling up my pool, and making it bigger and deeper. How then do I empty this pool? By selling the stock.

In a perfect world we would love for our purchases to arrive on the day we made our sales. In effect, we would just have a stream rather than a pool but, for most of us, we’re not in a perfect world so we do end up with this stock pool. If your stock pool is getting larger and chewing up a lot of your cash, you need to start working out how to shrink it.

To shrink your Stock there are two options. You can either slow down purchases or speed up sales. Let’s start with purchases. This brainstorming tool is to help you think about how to reduce purchases and get to as close to ‘just in time’ as possible.

Firstly, take a good look at your product mix and identify which items are turning over quickly, and those that are slower to move. Consider whether that slow-moving stock is worth the cost of holding it. If it’s a product that brings customers to your business who then buy other stock, or if it has a strong profit margin, then it may be worth it. Otherwise, look to offload it as soon as you can.

Then take a good look at your stock management system. Can you improve that system? Does it provide you with accurate and timely information? Do you regularly do stocktakes and match it to the system to maintain its accuracy? Does it alert you when it’s time to order more stock? Does your pipeline management system help you make accurate purchase forecasts? Particularly in highly seasonal businesses.

Also, consider buying less more often. While a discount on a bulk purchase may seem attractive, is it enough to outweigh the cost of storing that bulk stock and having your cash tied up until you can sell it. A temporary solution to quickly reduce stock is to simply stop buying for a short period of time. So, that’s a few things to consider to help reduce your stock by slowing down the inflow.

The other side of the equation is to increase the outflow by improving sales. One way of increasing sales is to incentivise your customers to buy more by offering a discount. Another is to incentivise your staff to sell more by offering commissions or bonuses, or perhaps even additional sales training. Consider whether your marketing is effective or whether perhaps you need to try something different.

You could also try packaging slow moving stock with a product that does sell well, or try selling it in a different marketplace, such as eBay. If none of these things are working and you’re still holding onto this stock maybe you could see if you could donate it to charity or a local school that will give you a little bit of goodwill and PR. At the end of the day write it off, and write it off sooner rather than later. These are just some of the ideas for shrinking your stock pool.

For a service business, instead of stock you need to look at Work In Progress or WIP to free up cash. Let’s have a think about this Work in Progress and how it flows through your business. Again, we’re going to use the pool concept to brainstorm ways of managing WiP.

We start out with the inputs of time and skills or, if you like, the resources needed to complete jobs. These are mainly people but could also include equipment with which you use their skills and time to complete jobs, so you can send invoices out. What we're interested in, is having the right amount of resources to complete jobs in the fastest time possible. You are usually paying for the time you have access to resources, if you don’t use that time you have lost that cash.

So, how do we make sure you have the right amount of time and skills to complete the work needed? I believe a good place to start is to have a pipeline management system that can give you a good indication of the jobs coming up and the skills, people, functions and equipment needed to complete them. Of course, you need to hire the right number of people with the required skills or attributes, and the right amount of equipment or space with the required attributes.

Can you use contractors, part time or casual staff instead of full-time employees? This allows you the flexibility of increasing and decreasing your resources as the number of jobs change. Do you know the capacity constraints of your resources? That is, how much work they can actually produce and in what time frame? Ensure the work being undertaken is productive. That is, income generating tasks, or tasks that will upskill for work in the pipeline, or ensuring admin is completed correctly.

Are you effectively rostering resources? Ensuring you are not using all your expensive staff at the same time, or all your inexperienced staff at the same time. And ensure you are not carrying any excess staff or equipment. This is all about making sure you keep your employees and equipment busy and occupied on revenue generating activities.

The other side to having the right resources is to ensure jobs are completed on time and you can get those invoices out as soon as possible. This gets back to efficiency. What we want to do is finish every job as soon as we can. You need to make sure your processes are efficient. You need to make sure that your employees stay motivated and productive. Are there any obstacles or bottlenecks that are hampering completion of jobs?

Is there a monitoring process in place so you can know what stage your jobs are at and you get early warning when they may be going off track? Part of monitoring is to know “what is the time to completion?’. And what keeps it all on track is the productivity of your staff and equipment.

In a service business, you need to make sure you’ve have enough jobs to keep everybody occupied, to keep all your capacity used, and that it is all being done efficiently and productively so that you’re getting the jobs, and the invoices, out the door as soon as you can. The better you manage this, the less chance there is of cash getting caught up in this part of your Working Capital Cycle.

So of course, the 3rd place cash can hide in your business is in Debtors. And again, we’re going to use the Debtor Pool as a brainstorming tool to help you identify where you may be able to free up cash. So, we’re thinking about debtors, like we have with stock and work in progress, as a big swimming pool. You fill it up by making credit sales and you empty it by collecting the cash from your customers.

The key starting point when offering credit sales is to consider what your credit policy is, because after all you are essentially lending your customers the money to buy your goods or services. Who are you prepared to lend your money to? And what criteria do they need to meet? This may mean that new customers need to establish a good track record with you before you offer them credit terms. At the very minimum its prudent to request references or do credit checks.

You also need to consider how much you are prepared to lend, and for how long? Your credit terms could include things such as deposit requirements, progress payments, payment options, and whether you want to be paid in 7, 10, 30 or 45 days. And this should all be shown on your invoice. And your invoice needs to be issued the same day as you provide the goods or services. Don’t lengthen your collection period by not issuing invoices promptly.

Once you have the money out there you then need to ensure you have the systems and procedures in place to collect those invoices in line with your terms. Consider a reminder system as the due dates approach, but definitely follow-up as soon as a payment is late. And follow-up in person on the phone, not just an email that can be overlooked. The squeaky wheel gets the oil so if you’re on the phone chasing your payment, you’re more likely to get paid sooner.

In some industries the offer of a discount can incentivise people to pay earlier, but it may also pay to have a penalty for late payment as part of your credit terms. Particularly when you’re dealing with large organisations, ensure you develop a relationship with the right contact. You need to be following up with the decision-maker not the processor. Keeping an aged debtor listing helps you stay on top of who is paying you and who isn’t.

You could also consider using an external debtor collection agency, or even invoice finance. Whatever it is, … shorter payment terms, a phone call, a discount … you want to make sure you get your cash in as soon as you can because the sooner you get your cash in the better your cash flow should be.

Remember your cash hides in your working capital cycle. Monitor your cycle regularly and make sure it is turning as quickly and efficiently as you can. In this video we covered ‘What is cash flow?’. Remember the cash flow budget is one of the most effective tools to help keep an eye on your cash flow. We had a look at the Working Capital Cycle to see where cash can pool or hide. Then we looked at a few ideas to get the Working Capital Cycle moving faster to improve your cash flow.

For more information on cash flow watch our ‘Optimising cash flow’ video. 20.57 Thank you for watching our ‘Managing cash flow’ video. We trust you found this information useful and relevant and I encourage you to check out the other webinars and resources on the Davidson Institute website to help build your financial confidence.