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Keep the cash flowing in a growing economy
Cash is the lifeblood of any business and the length of time between when
you have to pay items like your suppliers, interest on your borrowings,
employee salaries and the time you collect from your customer can give
rise to a thrombosis. Businesses don’t necessarily fail because they are
not profitable – most businesses fail quite simply because they run out of
cash.
Many more businesses will see their cash flow squeezed as the Irish
economy continues to improve – resulting in businesses having to invest in
more staff, bigger premises, new equipment and better stock. All this
needs to be financed and will place greater strain on converting these
assets into cash. Many businesses who weathered the worst of the
recession will fall into this deadly trap of overtrading in a growing economy.
The medication required to keep the blood circulating and prevent the clots
is Cash Flow Management.
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Cash Flow Management Tips
You can delay some payments beyond the due date but you may not be in
a position to delay payments on your bank loan or your tax bill unless you
want a visit from the Receiver. You can’t normally delay payment of
salaries without industrial unrest and you will run the risk of repossessions
if you don’t make leasing repayments on time.
For many organisations, cash flow management simply entails delaying
outflows of cash to suppliers until the last possible moment. However, this
approach won’t win you many friends with your suppliers who might
restrict the amount of credit they will extend to you and it will definitely
have an adverse impact on your credit rating.
Hundreds of Irish businesses are members of programmes that provide
their accounts receivable files to credit reference agencies that factor the
payment habits into their credit rating scorecards.
A poor credit rating narrows down the number of suppliers who will deal
with you; it might prevent suppliers from obtaining credit insurance on your
business and will almost certainly mean you don’t get as a good a deal on
your purchases as companies with a good credit rating. It may also have a
detrimental effect on your ability to raise short-term finance from banks that
often use variants of their own credit scorecards incorporating credit
reference agency data.
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Effective cash flow management boils down to three key areas:
1. Cash flow measurement, preparing cash flow
projections
2. Managing your receivables with the objective
of encouraging customers who owe money
to pay it as soon as it becomes due (earlier if
possible)
3. Prudence over the timing and payment of
purchases
All businesses should prepare a cash flow
projection on either a weekly or a monthly basis,
forecasting for at least six months, preferably a full
year in advance, making educated guesses for all
of the factors that might affect your cash flow.
These will include:
1. Timing of when you will be paid for sales already made; sales you
expect to make and all payables including supplier invoices, wages,
vehicle expense and location costs etc.
2. Make sure you monitor your actual performance against the forecast cash
flow on a regular monthly basis and identify any shortfalls that need
attention.
3. Never forget: even profitable new business can cause cash flow problems
4. Profitable companies can and do become insolvent when they have to
pay the costs incurred during fulfilment of an order before they receive
payment from their customer. This is generally referred to as
overtrading and to avoid this threat it may be necessary to either delay
some large orders to spread the fulfilment costs over a longer period, or
to ask the customer for a deposit.
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Most computer spreadsheets and business accounting software offer
templates that are either pre-installed or free to download but remember to
start with your cash in hand and account for any seasonal variations in
income or expenditure. If it looks like you are going to enter periods of
negative cash flow, look to find opportunities to reverse the negative cash
flows by deferring capital expenditures or offering improved terms that
encourage customers to pay more quickly.
If you do need to delay payment to a supplier, make sure you communicate
with them and try to gain their consent. A crucial success factor when faced
with a cash flow shortfall is acting early: the sooner you act the more options
will be open to you. If you go to the bank looking for an emergency overdraft
next week, you’ll get a much rougher ride than you will if you are looking for
a line of credit that you may not need for another six months. If the Bank
won’t help, consider other forms of business finance, such as factoring.
Factoring isn’t cheap. A Factor (invoice discounter) will advance payment on
invoices issued today that may not be due for payment for another 30
or 60 days. You can either start with future invoices, or go back over your
existing accounts receivable file. Many of the same Factoring companies can
also offer payroll funding, which for a fee will provide you between one and
two months’ grace on the payroll; they’ll take over the current month’s payroll
and you’ll pay them 1 or 2 months in arrears. The cost will hit your profitability
and reduce cash flow from operations but it will speed up cash inflows and
may prevent a cash flow crisis.
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In an absolute emergency, you could also consider raising cash by selling
and leasing back assets such as plant and machinery or vehicles in the
fleet; again, it isn’t cheap but it might beat the alternative.
Many cash flow problems can be averted by the adoption of robust credit
management processes that supervise customer payment habits and
prevent bad debts by avoiding customers who are at risk of insolvency.
Good credit management practices will speed up your cash collection,
control how much credit you provide and to which customers you grant
credit. The golden rule of credit management is never to give any single
customer more credit than you could afford to lose if the customer went
bust and never paid.
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Granting credit need not be a game of chance
Depending on your margin and bad debt
losses, it might be worthwhile considering
using either your own internal credit scoring
system or a credit rating agency to evaluate
your largest customers on a fairly regular
basis.
If you process 800 orders a year with an
average order value of €800 and 64 customers don’t pay, your credit losses
will be €51,200. You might be able to reduce these credit losses with the
adoption of an internal expert credit management system but a good credit
reference agency will be able to identify between 60 percent and 80 percent
of the customers who are unlikely to pay.
If the credit reference agency identified 70 percent of the orders that were
likely to default, you could reduce credit losses from €51,200 to €15,360 – a
reduction of €35,840. You should be able to easily translate this into impact
on bottom line but it would almost certainly be more cost effective to use a
credit reference agency in these circumstances. Always remember that your
existing customers are statistically almost as likely to result in a bad debt as
any new customers you take on, so if you are going to use the services of a
credit reference agency, make sure you check all of your larger customer
and not just the new customers.
G) If you haven’t been paid by 90 days use a debt collection agency. A good
debt collection agency will normally embark on an amicable collection phase
that will yield favourable results well before you incur any of the costs of
going down the legal route.
Finally, if an order looks too good to be true, it almost certainly is.