It is easy to slip into using a cliche when discussing the importance of cash flow management and planning. Who hasn’t heard the phrase “cash is the life blood of business”?
I’m certainly not going to disagree with the importance of cash flow. However, the life blood metaphor bothers me because it implies if you leak cash from your business, it will die. Of course, if you leak too much blood (or cash) for too long you will need urgent medical (or financial) assistance!
The key difference with cash is there is so much you can do to control, influence and plan its use so that leakage doesn’t lead to liquidation.
Understanding cash flow
The first step is to have a plan. This is more than just a budget of your revenue and expenditure. It should also include a cash return to the business owner, the purchase of plant, equipment or other assets needed to operate, financing of these assets, and inevitably for a successful business, the payment of tax.
This cash flow plan allows you as a business owner to understand how your cash is used. There are misconceptions that having cash in the business means there will be more tax to pay, or that spending spare cash reduces your tax. Unfortunately, this mindset can lead to reduced profitability, cash flow pressure, time spent managing creditors’ expectations for payment, and even worse, missed opportunities to expand when the time is right.
Having a cash flow plan before decisions on financing and expenditure are made allows you to test the alternatives and see where cash is locked up or committed.
Cash can be locked up by debtors using your business like a bank, by unbilled work in progress or by stock that doesn’t move. There is an underlying tension between having on hand every product a customer could conceivably want, and having cash locked up providing options for your customers. This tension only increases as a business grows, i.e. the greater the level of sales, the greater the amount of cash locked up in debtors and stock.
Cash can be committed to making debt repayments, paying long term leases, and investing in fixed assets. While all these uses of cash are often necessary to run a business, making sure the financing and investing options and levels of commitment are appropriate is key to successful cash flow management.
Timing is also an important factor to consider in cash flow planning. Many businesses are seasonal, inflation leads to increased costs, interest rates rise, and tax is due at awkward times.
The good news is effective cash flow management and planning empowers business owners to make decisions today to influence your bank balance in the future.
Taking control of cash flow
The power of a cash flow forecast is that you can make changes and compare alternatives and see the effects of these changes and alternatives on profitability and availability of cash.
The forecast allows an understanding of when the best time to expand might be and whether that expansion is worthwhile with the available financing options. It will also show when cash might get tight, or when there is an opportunity for you as the business owner to take a higher return.
Best of all, the forecast highlights the areas of the business to focus on and scenarios to prepare for now, to achieve financial goals in the future. Examples of decisions that can be made include:
- Taking out an overdraft or extending an existing one to pass through a temporary shortfall in cash
- Refinancing or restructuring debt repayments
- Reviewing stock levels and range offered
- Chasing debtors, or negotiating more favourable terms with suppliers
- Restructuring expenses to enhance profitability
- Building a fund to seize opportunities as they arise
Returning to cash flow forecasts later and comparing them with what actually happened is a great way to review decisions and improve the quality of the next forecast.
Cash flow forecasts are not just for new businesses. Existing businesses should use them to plan and assess options for the next stage in business development and growth.
Avoid falling short of cash when you need it and make a plan to take control the financial future of your business. Contact your
Moore Markhams advisor to discuss cash flow forecasting and how to best manage cash flow successfully.
Prepared by Callum Hayde, a Moore Markhams director. Callum provides business advisory solutions including cash flow forecasting, goal setting, software solutions and succession planning.