Why is ‘cash king?’
When your business has available cash (or increased liquidity) it’s more able to seize opportunities as they arise, upgrade its existing operations and plan better for the future.
Most small-to-medium sized businesses work on restricted budgets and limited resources, so a key part of improving your cash position is related not just to what you currently have, but what others owe you and you owe others.
In this article we will be covering:
Working capital management: The difference between what your business currently possesses (cash, accounts receivable, inventory) and what you owe (accounts payable, debts) is working capital. Consider how best to balance your assets and liabilities to maximise the cash available.
Credit control: Part of managing working capital effectively is to control the credit you give your customers (the money they owe the business). How you stay on top of, and act on, these debts will define how healthy your cashflow and working capital are.
Good cashflow will also affect your business’s credit score, which will make you a more appealing prospect for investors and lenders and potentially lower your interest costs.
While some see managing cashflow as an unwanted distraction from other activities, disregarding the relationship between what money is coming in and what’s going out of your business can certainly reduce your chances of success and even put its future at risk.
What follows are some recommendations that can improve the cash position of your business…
1. Specify
Creating a credit control policy that outlines the various processes, expectations and timings is important not just for those who owe you but also for your staff, so they definitively know how to proceed.
This policy could also cover client credit rating reviews and risk management procedures, such as late payment charges, different payment options and credit insurance.
Review this document regularly, so it is up-to-date with the latest regulations and the current economic situation.
2. Anticipate
If you are providing a product/service to someone where they will be in debt to you, ensure they know the full terms of credit (see above) before delivery. Explain how long they will have to pay this debt, whether you will be charging interest and what will happen if they do not pay in time. Be on the same page from the offset.
3. Invoice
Send an invoice as soon as you have delivered your product/service.
Be prompt and it will be fresh in the mind of your debtor, who will have more inclination to pay it.
Make it as simple as possible for the debt to be paid. Your invoices must be accurate and easy to understand; confusing information will only delay an already extended process. Offer an efficient payment method.
You might consider introducing early-payment incentives, as well as additional charges if they’re late.
Some methods to make this a faster or more reliable process include setting up a direct debit at the quote stage, or using a third-party application for clients to pay from the invoice (e.g. Xero and QuickBooks can have direct links to pay from their invoices).
Note, these options are not free and will cost you in either administration or transaction handling fees. Weighing up the benefit of the cash coming in sooner against the cost (usually a percentage of the fee) is an important decision to make.
4. Reciprocate
Pay your debts on time and not early, so the businesses you owe can stay on top of their cash flow whilst you make the most of their credit terms.
Building these positive relationships may mean you can negotiate better prices and credit terms. For example, if you can arrange to pay your outstanding debt by the end of the month, whilst your debtors are encouraged to pay at the start, you will have more cash available in the meantime.
5. Scrutinise
Look at your sales ledger and see which customers are approaching or exceeding their payment deadlines. Prioritise the businesses who owe you the most money and the those who have owed you for the longest time.
Set yourself reminders, so you’re certain when you should receive the debt.
6. Collect
Inventory (commonly called stock) is an asset that you can raise money by selling, but before this you must purchase and store it. Examples include items purchased to be re-sold, raw materials used to make a product and finished goods.
How much inventory are you holding?
If you have too much inventory, this means you will have a lot of cash tied up in stock that could fall in value, dependent on the market conditions. Additionally, it might be costing you to store this stock.
You must find the correct balance between having sufficient inventory to fulfil your demand, but not so much that you’re left cash poor.
You might consider:
Days inventory outstanding: How many days does an item sit in your inventory before it’s sold? How much of your inventory is sold in a given time? You want to reduce the time stock stays in your inventory to generate cash faster and recoup your initial investment.
Just-in-time: If possible, order the items just before you need them, as opposed to stockpiling them.
7. Streamline
Conduct a bottom-up budget to determine what liabilities can be reduced or aren’t needed at all, this might include unused machinery or subscriptions, alongside other expenses that don’t add value to your business.
What could make your operations more streamlined to stimulate productivity and reduce waste?
Have you renegotiated contracts with your outsourced partners, so you are getting the best possible deal?
It will require careful examination (and potential consultation) to determine what these liabilities are. Be sure the processes you intend to dispose of aren’t integral to the product/service you provide before you remove them or alter your existing processes.
8. Communicate
Maintain personal relationships with your clients throughout the credit period.
Send a reminder a week, or a couple of days before the debt is due, so your debtor is properly prepared.
Alternately you may opt for a more light-touch approach, with email or phone calls where you don’t even mention the deadline explicitly. By being forefront in their mind and building rapport, you increase the chances of punctual payment.
9. Check
You may be credit checking new clients, but are you checking-up on existing clients?
The financial situations of people and businesses can change quickly, so it’s worth staying abreast of their credit ratings, even if your relationship has been seamless so far. This will mean you organisation can avoid possible difficulties before they occur. Chasing the money after the fact will be far more complex than this initial check.
10. Act
If someone has missed their payment deadline, remind them in a professional manner. There are many reasons why people might exceed their credit agreement, where many are unintentional and legitimate. If appropriate, you may work out an alternative solution that suits both parties, such as an extension. You may well do business with this person/organisation in the future, so it makes no sense to burn bridges.
However, you must be assertive. Let them know you will need this money and what the potential consequence might be.
Should they refuse to pay you or ignore your communications you may wish to employ a third party to retrieve the debt for you or commence legal proceedings. This should only used as a last option, as it will cause a degree of upheaval for you, your business and your client, as well as incurring additional costs.
Need some guidance?
Controlling your cash should be an everyday concern, particularly if you have a lot of transactions going in and out of your business. Having cash available will mean your organisation can make more front-footed decisions, and not having enough will put you in some difficult positions.
Some larger businesses employ a full-time financial controller, while others assign weekly time to review their cash position or outsource this process. No matter the approach, updating the sales ledger, communicating with creditors and debtors and conducting credit control activities is essential.
With good cashflow information businesses can forecast ahead for more insightful planning. This means funds available can be determined in advance, so you know where the money is coming from/going to and when.
If you are interested in how your organisation could better manage its cash and enjoy the consequent benefits, then please contact us and member of our team will be happy to discuss this with you…
