While we as business managers have already known how to solve Cash Flow problems, it is always better to prevent the diseases rather than cure it.
Serious cash deficiencies can be avoided, if simple yet important steps are taken by business managers:
1. Plan cash better. Construct Cash Flow Forecasts, so that the liquidity and Working Capital needs of the business can be assessed month by month. These can help the management of Cash Flows and Working Capital needs. Keep this updated and also show it to the bank manager. Cash can be managed by planning for periods when there might be too little cash and arranging for a possible overdraft to avoid a liquidity crisis. Also, wise use or investment of excess cash.
2. Inject sufficient capital as Opening Balance. When starting up the business put into the firm enough money to last for the first few months of operation when Cash Inflows from customers may be slow to build up.
3. Manage customers and debtors properly. Debtors (Accounts Receivables) can be managed in many different ways:
- Not extending trade credit to customers, or giving it for short period of time. Use effective credit control over customers’ accounts – do not allow a period of trade credit that is too long, and regularly chase up late payments. However, customers may not buy from this business anymore as many customers now expect credit and will go elsewhere, if it is not offered.
- Selling claims on trade receivables to debt factoring companies. These businesses are specialist financial institutions who will ‘buy’ outstanding debts from other businesses that have an immediate need for cash. This will involve a cost of usually 10% or 20% as the debt factoring companies never pay 100% of the invoice value.
- Investigating to discover whether new customers are creditworthy. This can be done by requiring references from traders or from the bank, or by using the services of a credit enquiry agency to investigate the past history of payments.
- Offering discounts to clients who pay promptly and in full. Although this will increase the amount of cash collected quickly from the customers, any discounts given would reduce the profit margin on a sale.
4. Manage suppliers and creditors properly. Creditors (Accounts Payable) can be managed in many different ways:
- Extending trade credit period taken to pay suppliers. The larger the business is, the easier it is to extend the credit. This will improve the larger firm’s Working Capital. Slow payment by larger businesses is often a great burden for small businesses that supply them. However, some suppliers may be reluctant to supply products, if they consider a business to be a ‘late payer’.
- Increasing the range of products bought on trade credit. If a business has a good credit rating, this may be easy to order additional products. The danger is that an unpaid creditor may refuse to supply and this will cause production hold-ups. In addition, discounts offered by suppliers for quick cash payment might be given up.
5. Establish good relationships with lenders. For example, have a close and trustworthy relationship with the bank, so that any short-term cash problems may be overcome with an overdraft extension, or a short-term bank loan.
Check out my tips for solving Cash Flow problems. You will find among them different methods of improving Cash Inflows, reducing Cash Outflows and seeking alternative sources of finance to combat negative Closing Balance.
