Focusing on growing the business and maximising profitability should always be top priorities for small businesses. However, concentrating on these areas alone can mean neglecting crucial cashflow practices that can lead to the demise of your business. Sue Hirst explains.
Now that we seem to have come through the ‘Global Financial Crisis’ and the ‘Downturn’ in Australia, it’s time to gear up for growth again.
A question that often arises in growing businesses is, “How come I’ve made more profit, but I still have cashflow problems?”
The answer to this question lies in the issue of the Cashflow Cycle. This cycle is an issue often overlooked by small business owners until business starts to grow and they begin to experience ‘cashflow squeeze’.
Let me explain how it works.
In the diagram below you can see a timeline of 365 days.
The diagram shows:
- Before you can sell anything you have to buy something on day one (i.e. stock, or labour if you run a service-based business).
- Depending on your sales cycle (i.e. how long the stock sits in store), you may hold onto stock for 60 days.
- Depending on the terms you get from suppliers, you may have to pay for that stock after 30 days – which means you have 30 days negative cashflow.
- Depending on your accounts receivable management, you could wait 60 days to get paid — which adds another 60 days negative cashflow.
- This adds up to 90 days negative cashflow.
This means your money has been somewhere other than your bank account for 90 days (i.e. in the bank account of your supplier and your customer). This is referred to as ‘funding the sale’. This is also known as ‘working capital’ which means that you need to have a certain amount of money to fund sales all the time.
Why the above causes a problem when growth occurs, is because the issue just gets bigger. If a business isn’t working to minimize the number of days stock is in store and the number of days customers are taking to pay, the problem just gets worse when sales grow.
Sometimes businesses get very focused on increasing sales and the issues of stock movement and accounts receivable get ignored or are not considered worth investing in. This is why growth can often kill what appears to be a profitable business.
To minimize the number of days stock sits on the shelf you need to work on your buying procedures and calculate when stock will be required by customers. If you are in a service based business you need to minimize the number of days jobs are in progress. You need to eliminate inefficiencies and rework on jobs or products.
To minimize the number of days customers are taking to pay you need to implement a system to ensure that customers are invoiced as quickly as possible and everything is done to ensure customers pay as quickly as possible. There are some terrific debt management systems available, that help humans perform efficiently and debts are handled appropriately for the level of the debt i.e. some need to be followed up by email and some need to be followed up by telephone.
A lot happens to cash on its journey from the sale to your bank account. If you are planning to grow your business you must understand and work to improve the situation, or you could be heading for problems.
Sue Hirst is a director of CAD Partners, a nation-wide mobile CFO “On-Call”/financial control/business accounting service for SME owners.