It is rational to rely on figures and metrics when making a cash flow decision. To leave it all to gut feel won’t work. Yet, there are business owners who keep their fingers crossed and simply hope for the best. Anyway, the business seems to be doing fine and incomes are high year in and year out.
Unfortunately, some entrepreneurs think that cash flows and income are directly linked to each other. The truth is they’re not aligned. You can have positive income and yet have a negative ending cash balance and vice versa. This is so because of timing differences, among other reasons.
A cash flow measures your business’ capacity to settle bills on time. Your ending cash flow is a result of your cash in and cash out activities for a certain time period. For SMEs whom faces cash flow gaps, the most common form of solution undertaken is to obtain external financing via a business loan in Singapore.
The importance of a positive cash flow can never be undermined. Cash is critical to running your business. Ideally, cash that goes into your business should be more than amount of cash that goes out. You take out cash to purchase supplies, pay rent, settle debts, meet payroll, and other expenditures. After paying for all these, there must be a comfortable cash balance left for succeeding business cycles. This scenario makes for a more healthy cash flow.
So how do you create a stable cash flow and ensure that your business runs smoothly with minimal bumps along the way?
Here are six ways revealed.
Choose credit worthy customers
While cash is preferred, often times, you will have to sell to customers on credit to drive sales. Selling on terms is common practice but it has its downsides too. Clients may pay late or worse, not pay you at all and make a disappearing act. There is always an receivable default risk when selling on credit.
There’s no guarantee that on each trade, customer will pay you on time. However, you can be proactive, initiating steps to ensure that you’re not working with bad customers who hibernate when it’s time to foot the bill.
So how do you go about differentiating the good eggs from the bad? Ask for references and Investigate.
But first, prepare a credit application form and ask every potential client to fill it out. A standard credit application form will ask for details like business name, address, and contact number of the potential client and those of his named banks. If it’s possible, try to get some references from other suppliers but this is not a common practice.
Next, contact all named references and get some feedback about your prospective client. Inquire about his paying habits. Does he pay his dues on time? Does he habitually ask for payment extension? The answers to these questions can help you paint a picture of how well he honors his financial commitments with creditors.
However, do note industry feedback on a particular company’s credit conduct is likened to a general opinion and may not be as accurate as you would expect.
Adopt an effective collection policy
One of your concerns as a business owner is to efficiently manage your account receivables (AR). You should be collecting your receivables on time without delay. Timing and speed are important. The period it takes to collect AR should be shorter than the period it takes you to settle your account payables (AP). You can achieve this model if you have a sound collection policy.
What makes for a good AR collection policy? Here are three attributes:
Keeps track of notices and demands
Invoices you send indicate when goods are payable. It’s usually within 30 or 60 days. Despite the clarity of payment terms, some creditors are still remiss on their obligations. Many will promise to pay at a later date but eventually, break that promise. A sound collection policy allows you to address this issue but you have to be consistent. Make it a policy to send a series of written notices. The first notice may be sent within 7 days of non-payment. The second and third may be forwarded about 15 days and 30 days respectively after non-payment, with a stern warning of a credit hold on the third notice. Never be remiss about sending notices and keep proofs of receipt of such notice/demand.
Create a sense of urgency
The written notices and demands you send a client should prompt him to be on his toes and to act fast. Always be persistent and mean what you say. Walk the talk otherwise, clients won’t take you seriously. The sooner he pays you, the better for your cash flow and your business.
Open to negotiations
You must be open to negotiations with deserving clients. It is easier if you have established parameters on granting payment extensions or other concessions. State the conditions that warrant an extension of payment, the percentage of obligation that can be paid in staggered amounts, and additional charges for extending credit. Remember, there are good clients who are willing to pay but couldn’t at the moment due to unforeseen cash flow problems. So if he asks for concessions, be open to negotiations if you think he can get back to his previous status as a reliable client. If does, you both win in the end.
Manage your payables
One of your goals in managing cash flows is to make sure that your inflows exceed your outflows. With proper planning, account payables (AP) can be easily managed and used to optimum advantage.
It pays to have an overview of your AP. Don’t miss the forest for the trees. While it is important to look at the details – what you spend on, how often you spend, your payment process, seasonal trends, patterns, and the like, you must have an overall picture of how all these affect your AP and your cash flow.
Part of effective AP management is selecting reliable vendors and ensuring that you establish good relationships with them. Vendors value clients who pay their dues on time. When you are a valued client, you can call them anytime and advise them about your supply needs. You won’t hesitate to ask for discounts in reasonable situations like bulk orders.
In case of cash flow emergencies and you can’t pay on due dates, you can rely on their understanding. They can even extend your due date for a few more days. Vendors appreciate clients who take the initiative to give a heads-up about a payment becoming delayed by a few days.
Delighting your vendors doesn’t mean paying them in an instant. You must have a strategy. Know which vendors to pay first. When there’s an opportunity to pay in terms (30 to 90 days), take advantage of it. That way, you maintain more money in your cash drawers and use it to your advantage while waiting for obligations to become due.
If your company is already operational for a few years, you can also consider applying for trade financing facility from banks. It is a form of revolving credit facility which you can drawdown your credit limit to make payment to suppliers first while enjoying 90-120 days credit terms from your bank.
Always update your cash flow budget. It will help you know how you are positioned at a glance. It is faster to weigh your options and make informed decisions when all the information you need is on hand.
Look for ways to speed-up cash inflows
Try to narrow the gap between receiving payments and depositing them to your bank account. Accepting physical cheques as payment can unnecessarily lengthen your accounts receivable cycle. Paper cheques have to be delivered or mailed to you plus, you need to drop by your bank to make a deposit with a 1 to 2 days cheque clearance. There are ways to cut the cycle.
If you are emailing invoices anyway, why not create an online website portal where clients can go to a link to remotely pay for their dues. If you offer the convenience of paying through credit cards or direct deposit, you are raising your chances of getting paid right away. It is much easier to settle a payment transaction that gets done in one click rather than typing out a cheque, waiting for signatories to endorse and mailing it out.
When you have clients purchasing your products online, it is but logical to create a payment gateway. Don’t forget to indicate acceptable credit cards. Many clients will find it very convenient and safe to make payments for minor purchases online via recognized payment gateways such as Paypal. If your clients feel quite secure doing online transactions with you, expect to get your cash in minutes, not days.
For retail businesses, you can also encourage customers to pay with cash as much as possible as payments via credit cards will incur additional merchant fees and there’s also a few days processing time from terminal providers before crediting payments to your account. However, if you do receive significant cash payments, it is critical to establish internal effective cash handling practices to minimize staff pilferage and theft.
Alternatively, you can also utilize factoring facilities from banks to unlock unpaid cash in your client’s invoices. With factoring, you can access up to 90% of cash from your invoices instead of waiting for clients to make payment after credit terms granted.
Mind your debts
Is it possible to have consistently high bottom line figures in your P&L statement and yet you find yourself cash strapped? Of course, it’s possible and one of the culprits could be your outstanding debts.
There are metrics that you can use to determine whether or not your business is over saddled with debts. The two ratios commonly used to test your debt levels are the Debt-to-Asset and the Debt-to-Income ratios. To calculate, simply divide total debts by your total assets (D/A ratio) and your monthly recurring debts by your monthly gross income (DTI ratio)
Low debt ratios may reveal that you are able to strike a good balance between your income and obligations. Some businesses thrive with a 20% DTI ratio, others are comfortable with 40%. A sound debt level will vary across different industries so it’s best to compare yours with those in the same industry.
If your debt ratios are relatively high, you might want to approach your creditors and probably negotiate for softer terms. While a rate reduction may be difficult to justify, applying for longer repayment terms or a balloon payment on principal may be a more realistic route.
The earlier you talk with your creditors about your cash flow issues, the better. Creditors will appreciate your honesty and initiative and it is beneficial to establish trust in your banker relationship. It’s also a sign that you are a proactive business owner and not one who simply waits for things to eventually self-correct.
Keep forecasts as accurate as possible
The accuracy of your cash flow forecasts rests on two critical activities – frequent review/updating of cash flows and use of historical data to come up with detailed estimates.
How often should you revisit your cash flow forecast? A weekly or bi-weekly review is recommended but if you deem it’s best to do it more often, it’s your call.
Reviewing your cash flow presents the opportunity to assess how effective you are in managing your operations. Pay attention to your cash conversion cycle (CCC) and determine how fast you convert your inventory to cash.
Calculate your CCC by summing up your Days Sales Outstanding and Days Inventory Outstanding. From this sum, deduct your Days Payable Outstanding.
A negative value is ideal. It reveals that you’re able to receive payments for your goods ahead of time, allowing you to pay suppliers using the cash received. A good business practice involving your AR and AP accounts will help propel your CCC to a suitable level.
It is a good practice to solicit ideas from staff when doing cash flow forecasts. That way you cover every possible scenario when making assumptions.
When estimating sales, refer to your historical sales performance, factoring in observed seasonal trends and patterns each year. Also, investing in CRM software that may have positive impact on your projections. Study the market too. There may be new entrants that could have a negative impact on your future sales.
Determine when you will get paid by customers. Look at your average Days Sales Outstanding and from there make assumptions when cash is expected from clients.
Estimate fixed and variable costs. Fixed costs are easier to project since most of them do not change significantly. As for variable costs, you may have to look over your sales projections as these types of costs may rise or fall depending on your production volumes.
Essentially, the secret to having a healthy and stable cash flow is having sufficient cash anytime you need it. You can achieve this when you know how to effectively manage your cash sales and AR as well as your expenditures and debts.
Now that the secrets have been revealed, it’s time you take action and get them all done.