cash flow

The Importance Of Cash Flow

For any business, cash flow is vital, and this is especially so for SMEs who are not as well capitalized.

In today’s business environment where disruptive technological changes can upturn an entire industry in short time, it is increasingly challenging for a small business to survive and thrive.

In today's rapidly borderless and globally connected ecosystem, size does not matter as much as speed.

Small businesses are swimming against the current as the marketplace becomes increasingly competitive. Those who executes the fastest will ultimately survive.

In such an environment, it is imperative for the SME owner to keep a keen eye on your cash flow.

Cash is the company’s life line. If cash flow is disrupted, it will eventually endanger the company’s survival.

If customers start delaying payments and the company has to fulfil monthly overheads, it will eventually lead to a negative cash flow position.

A strong positive cash flow position begets a virtuous cycle, as the business will be able to invest in development, improve its products and services and hire better talent. This in turns will strengthen the business's competitiveness.

For local SMEs, they can tap onto a SME loan in Singapore if immediate cash infusion is necessary either to tap onto unforeseen opportunities or to tide over a temporary cash flow crunch.

Cash flow statement

Most SME owners when assessing their company’s financial performance only look at their Profit & Loss statement and Balance Sheet.

One important statement frequently overlooked that forms the company’s financial report is the Cash Flow Statement.

cash flow statement sample

 

There are 2 critical questions you should ask concerning your company’s cash flow statement:

  1. Did my net cash flow from operations increased or decreased compared to previous financial year?

  2. Where did I spend my cash on? On operations, investment or financing?

By answering the above 2 questions, you’ll be able to gauge the quality of your cash flow.

The net cash flow from operating reflects the net cash flow attributed to normal business operations, which is the net value of the operating cash inflow minus operating cash outflow.

Net profit, from the perspective of the Profit and Loss Statement reflects the profitability of the business for the relevant financial year.

In simplicity, it’s the total income of the business minus the total costs and expenditure.

Among them, income includes operating and investment income. Total costs include the cost of goods sold and non-tangible costs (such as depreciation and amortization).

A very important indicator of the quality of profitability is the comparison of operating net cash flows and net profits.

Under a very simplistic scenario, if a company’s income is pure cash income and all costs are also paid in cash, in which case the net profit will be equal to the operating cash net cash flow.

However in reality, there will be a difference between net operating cash flow and net profit due to the below factors:

Accrued income such as debt receivables

The longer your receivables turnover day, the more your customers are using you as an interest free business loan.

Credit terms extended to customers should rightly be recognized as a cost to the company as there are opportunity cost if cash is received right after sales.

Non-cash expenditure

Amortization and depreciation of assets are non-cash expenditure of a business.

Many companies use EBITDA (earnings before interest, tax, depreciation & amortization) as a more accurate measure of business profitability because costs like amortization does not have real cash flow expenses.

The impact on working capital

Working capital includes prepayment and advance payment. Firstly, whether a company has a revenue pre-payment business model is largely dependent on its industry.

For example, the education industry usually collects its revenue of tuition fees in advance before delivering the service (conducting classes).

The education industry would therefore enjoy positive cash flow since its able to collect the full semester’s tuition fess before it has to discharge the costs of business (rental and teachers’ salaries).

If a company’s operating cash net cash flow is sufficient to meet the day-to-day operating expenses, it indicates that the company can generate its own cash flow to maintain development and growth.

If the net profit growth of a business substantially exceeds the growth of operating net cash flow, it is necessary to understand how capital is utilized in the business and the financing channels of the enterprise.

For companies with tedious receivables payment terms and slow inventory turnover, if there is no consistent financing support or access to capital, the company might run out of cash eventually despite being profitable on paper.

Receivables (AR) Management

Most SMEs' primary concern is survivability and almost all are in a relentless hunt to improve revenue figures.

Receivables management however should be prioritized over just pure topline sales growth, especially so for younger SMEs who are less capitalized.

What good is high revenue growth if you’re constantly firefighting collections issues to generate sufficient cash flow?

Ways to improve accounts receivables cycle

It is prudent business practice to prioritize customers whom are willing to pay cash terms for your products or services rather than those whom place large orders in exchange for lengthy credit terms.

This is especially so if the potential buyer is not someone you had a working relationship previously or a reputable name in the industry such as MNCs or government related entities.

A savvy business owner would rather lose a deal than to play the role of a financier by extending excessive credit terms to new accounts.

When your customer uses your credit terms as a form of financing, they effectively save on business loan fees. Do not let customers abuse your credit terms as a interest free loan facility.

Ultimately, collections of payment will directly affect your cash flow. You can’t use your revenue figures or purchase orders to settle rental or make salary payments.

Cash is king should be the mantra of all small businesses. If need be, short term funding such as factoring could be obtained to improve company’s cash flow position while waiting for receivables to be collected.

Government financing schemes such as the SME Working Capital Loan or the Temporary Bridging Loan could be useful to bridge a short term cash flow gap as such schemes typically do not bear early redemption penalties.

You should also establish clear receivables guidelines and credit management within your sales and accounts department.

Receivables recovery is an unavoidable, challenging work that no one likes. However, it is critical to manage receivables promptly to ensure that company’s cash flow position stays healthy.

It is commonly accepted that the longer a debt remains unpaid, the lower the chances of full recovery.

Never let receivables that have already been past due stay due for too long a period lest it turns delinquent.

Implement a standardized procedure in your company on how to deal with delinquent debts. Consider engaging legal means to recover bad debts after all other less intrusive methods of engaging the debtor is exhausted.

There are also many other methods SMEs can implement to improve cash flow position.

By prioritizing collections and receivables management over just revenue growth at all costs, your company’s working capital cash flow will be much stronger.

Summary

Always keep a sharp eye on your cash flow.

Encourage your debtors to repay earlier by offering slight discounts (if your margins are not razor thin). Move your inventory aggressively and don’t let them stack up in your storage. Insist on a minor percentage of sales figure as deposit.

Whenever possible, try to position your business model to one that is cash flow friendly. Example would be F&B or retail businesses where cash is collected daily and expenses are paid monthly or longer.

This might not be possible for most B2B businesses especially those selling to large enterprise accounts. However, there are no limits to an entrepreneur’s ingenuity and resourcefulness to iterate and improve your business model.

Always remember the golden rule of working capital:

Profits don't pay the bills, it’s just an accounting term. Your business sustains on cash flow.