Managing cash flow is an essential element for the success of business, and often referred to as the oxygen of business. The more entrepreneurs understand about their cash flow, the more empowered they become. There is a saying that, “Top line (read revenues) is vanity, cost is calamity, and cash is king!” This statement could not be more true in times of uncertainty when every entrepreneur is dearly looking for survival.
There are number of aspects to be factored in for determining the cash flow — accounts receivable, accounts payable, inventory, capital expenditures, and debt service. A laser focus on each of these drivers of cash, in addition to the profitability, is essential.
Cash flow management is not always about sourcing additional funds for the organisation but more importantly optimally utilising the available funds! This pandemic has left the small and medium-sized entities (SME) with serious scars being unprepared. Following are the some of the techniques to manage cash efficiently
Rolling four-weekly forecast
A survey conducted by Oxford Economics and SAP of small and mid-sized businesses indicated that the businesses cite risk management (55 per cent) and spend visibility (45 per cent) as top challenges for their function. Managing Cash Flow is akin to driving a car. You cannot drive it looking at the rear-view mirror neither be happy at looking at what is just in front of you.
Forecasting the inflow should bear in mind as “How much inflow?” “From whom and when?” and the outflow could be arrayed between the Critical (Business survival decider), Major and others. Four-weekly forecast could pose alerts for the business. Based on the expertise, variation in the forecast, that had to be done a rolling basis, should not exceed 3 per cent in the next immediate week, 5 per cent in the second, 7 per cent in the third, and 10 per cent in the fourth.
Managing receivables
“Receivables” is defined as the frequency within which the money pumped into the business is taken back with a margin. The shorter the velocity, the more the efficient the business operates and expands. Measuring the cash-to-cash cycle is critical. For monitoring receivables, a simple ABC analysis of receivables, where the cumulative 65 per cent of receivables constituting “A” the next 25 per cent “B” and the last 10 per cent being C, would help. All “A” category should be monitored weekly, the “B” fortnightly and “C” monthly.
Send invoices immediately when the work is completed. Consider offering discounts for immediate payments, ensure that the trade-off is worth the marginal higher cost. It may impact your profit margin, but it may help to increase the cash velocity by incentivising customers to make payments earlier than billing cycles require. Ensure proper credit checks/worthiness of new customers as much as monitoring existing ones. Monitoring is nor a one of excuse and should be undertaken on periodical intervals. Consider using factoring, as they eliminate the hassle of collecting and be able to fund current operations without borrowing.
Managing payables
The bottom line is equally impacted by the turnover and cost. In complacency of expanding sales, the control over cost should not be ignored. Choose the bills you pay. Optimum utilisation of the credit period of vendors, Identify vendors with flexible payment terms low price chargers. Consider vendors' discounts for earlier payments thus efficiently controlling the working capital.
Managing inventories
Inventory is a silent killer. Having the right products, right quantity, at the right time. When done effectively, businesses reduce the costs of carrying excess inventory while maximising sales. Revisit to vendors to reduce the cycle time for delivery. Obtain the real time movements of stocks. Regular review on the low turn stock and devise strategies to offer it at a discount or in form of promotions, to improve the cash velocity. The number of times the inventory is turned around and a right balance between being resilient and minimising the cash blocked in the inventory, is critical.
Economic Order Quantity (EOQ), Days Inventory Outstanding (DIO), Safety Stock and Reorder Point are some of the techniques. The ABC technique, discussed above, could also be used here.
Managing the Capex
Managing capex is important lever in managing the cash flow and achieving cash excellence. A robust mechanism to be in place for allocating their capital and process for capital maximisation. Capex being a long-term investment should necessarily be matched using long term funds like equity from promoters or long-term loans. Economic uncertainty elevates the need of the dynamic capital allocation and reallocation. Ideal reallocation of capital on a one, three, and six-month basis rather than on an annual basis. Allocation in the higher ROI is the key.
Managing debt service
Cash short falls are inevitable if the entrepreneur cannot perfectly predict the future. The key to manage is to anticipate and be aware of the possible hurdles in line with the prevailing circumstances. Advisable to arrange for access to a line of credit, which allows you to borrow money up to a pre-set limit at any given point of time. Arrangements could also made with your suppliers through additional credits, to fund your business when in need.
Monitoring free cash flow (FCF)
Free cash flow is an evaluative indicator for business valuation. It shows how efficiently the business generates the cash. It is calculated by net operating cash flow minus capital expenditures. Regular monitoring and comparing with competitors shall pose diverse perspectives in managing the cash. This is famously captured as, “Profit is Opinion but Cash a Reality. Positive FCF indicates that the business has generated cash “not profits” in excess to the operational/ capital expenditures. It is relevant to note that increasingly businesses are valued based on FCF.
In the ultimate analysis, it is imperative for each business to ensure that the cash is used efficiently and optimally. This can truly make or break business.
(The writer is Partner, RVKS and Associates, Chennai.)