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Making your cash… flow


You’ve probably heard the saying ‘Cash is King’. Cash is not King any more… ‘Cash is now the whole Royal Family!’

We are hearing about businesses big and small struggling with cashflow, and insolvency is on the rise. Business has had the benefit of good times in the past, with many telling us they didn’t need to worry about profitability and managing cashflow. Now that the good times are over for many business sectors, we need to focus more attention on tighter management of cash and profit.

Cashflow problems often arise due to lack of understanding of how cash moves through a business and the difference between profit and cash flow.

Here is a chart showing the difference between profit and cashflow:

Profit Vs Cashflow
Aug 20xx
Income $1,000.00 Pay for Cost of Sales Jul 20xx $500.00 $500.00
Cost of sales $500.00 Pay for Overheads Aug 20xx $300.00 $800.00
Gross profit $500.00 Receive Payment from Client Sep 20xx $1,000.00 $200.00
Overheads $300.00
Net Profit $200.00


You can see on the left that the income, costs and overheads are all accounted for in the same month and we show a nice profit of $200.


On the right we can see that we had to pay for the costs before we actually made the sale. Costs might be products or labour and materials on a job. We also paid for the overheads in the month that we made the sale. Overheads are things like rent, admin, wages, postage, etc. We then had to wait until the month after we made the sale to get paid by the customer. Up to the month we made the sale we had paid $800 in costs and overheads before we had received a cent from our customer. We had to find $800 from somewhere to fund this sale.

This is where many businesses get into trouble with cashflow. They don’t allow enough cash to cover the costs and overheads until the time they get paid by customers.

Managing cashflow

The above diagram demonstrates there is a need to handle the shortfall of $800. You can do this by various means such as bank borrowing, lending the business money, selling shares in the business to introduce more cash, and so on. Alternatively, you can better manage the factors affecting the shortfall.

The factors affecting cash

These are sometimes referred to as ‘drivers of cash flow’. They are:

Revenue Growth. As you saw from the diagram, sales create a need for cash. So it follows that the more sales you make, the more cash you will need. This is an often misunderstood concept. Lots of sales are being made, but cash is getting tighter. Interestingly, a drop in revenue can sometimes cause a short-term improvement in cash because fewer costs are being incurred to make the sales, or inventory is being used up.

Costs and overheads percentage. The percentage of costs and overheads is important to know as well as the dollar value. This is because a percentage indicates how the costs and overheads are moving relative to the revenue. If you are selling more but your costs and overheads are growing by more relatively, you aren’t really getting ahead. If your revenue is growing by five percent but your costs and overheads are growing by 10 percent, you are missing out on vital profits.

Price change. If you don’t do regular small price increases, your margins are being eroded. Markets influence pricing but you need to find ways to increase the perceived value of your product or service to justify charging more. Regular small price increases are much easier to achieve than irregular big ones. Discounting is a hot topic at the moment, with many businesses offering them to retain business. Have you ever calculated how much more volume you need to sell to compensate for discounting? If you have gross profit of 60 percent and you offer a 10 percent discount, you need to sell 20 percent more volume to maintain your 60 percent gross profit. It might be better to find a low-cost addition to the sale with a higher perceived value than slashing your gross profit.

Accounts receivable days. This is the number of days ‘on average’ that customers are taking to pay you. This is quite different to the credit terms you offer. Anything you can do to reduce the number of days that customers are taking to pay you puts that cash into your bank account for longer.

Accounts payable days. This is the number of days ‘on average’ that you are taking to pay your suppliers. Anything you can do to lengthen the number of days you are taking to pay suppliers puts that cash into your bank account for longer. Obviously, you need to manage this against the level of service you receive. Some suppliers are quite prepared to offer better terms to keep your business.

Inventory and work in progress days. This is the number of days ‘on average’ that stock sits in store or jobs are in progress prior to invoicing. Try to think of stock as dollar bills piled up on the storeroom floor and ‘Work in Progress’ as dollar bills piled up on the workroom floor. Anything you can do to reduce the time stock sits in store and jobs are able to be invoiced will put cash back into your bank account.

If you can focus attention on better managing the above ‘drivers’ of cashflow, you may not have to borrow or sell shares in your business.

Cashflow forecasting

Another really important aspect of cashflow management is forecasting. We often hear the question “How can I predict when I will receive cash from customers?” This is a common issue in small business. However, you can start by plotting your costs and overheads in a spreadsheet and using that knowledge to calculate what cash you need to cover them. You can use prior knowledge of customer payment habits as well as making follow-ups to get the money in faster.

If you forecast a shortfall in your cash position (i.e. an overdraft or exceeding an overdraft), at least you are forewarned and can take action to avoid it. You can focus on selling more or collecting more quickly from customers. You can look at your purchasing of goods and services and time them to fit in better with your future cash position.

It can be very tempting if a lump of money comes in to spend it on items that you feel are needed, but a forecast can often demonstrate a need down the track for the funds spent.

Sue Hirst is a director of CAD Partners, a nation-wide mobile CFO “On-Call”/financial control/business accounting service for SME owners.

Photo: Mykl Roventine