Managing Your Cash Flows: Part Two
About the Author:
Paul Wilton (editor)
CA with degrees in commerce, accounting and information technology. Paul worked overseas in the “Big 4” accounting firms and served as a director at Audit New Zealand before setting up his own consultancy. Author of A-Z of New Zealand Business Law, Paul has over 20 years of experience as a business owner and consultant. He joined FBA in 2004 and is totally committed to providing excellence in quality and value to our subscribers.
In our last issue we introduced the principles of cash management and this is the second of a three part series feature article.
We will examine further the effect of debtors on cash flows, payments to creditors, increasing sales and reducing costs and getting quick cash.
Debtors
Improving debtor management has a significant and immediate effect on your cash flow and it is one of the easiest means of pulling in cash more quickly but most businesses are not good at it!
Debt Management Policy
Most companies do not have a debt management policy. This means that when problems are encountered then the same amount of time is wasted each time. It is essential that you instigate a debt management policy that covers issues such as:
How many reminders
Maximum time between reminders and Final Demand
Which accounts go to a debt collection agency and when
Whether defaulters are listed with a credit agency
Under what situations the legal process is pursued and using which process
Discounts
You need to consider whether to offer discounts for cash at point of sale (up front) or discounts for early payments.
Time Management of Debts
The longer you leave the debt, the less likely you are to recover the debt. Smaller business operators get too caught up in the day-to-day operations management of the business that the debtor’s ledger simply goes unnoticed until the debts are a number of month old. Moreover, some business operators simply do not have a “confrontational” personality. They put off calling a debtor through fear of confrontation. Most debt resolution issues occur amicably and are not confrontational at all.
Consider Outsourcing
If you do not have appropriate in-house debtor management skills then consider outsourcing. Further, use a debt collector when required. This type of thinking almost ensures the write off of the majority of bad debts. To remind you, where net profit is 10% of sales, a $1,000 write-off is equal to $10,000 of lost sales - not to be taken lightly!”
Only a small percentage of debts that are sent to solicitors or debt recovery agents actually end up in court. What they do ‘quickly’ is find the debtor, make contact with the debtor, and agree an arrangement to pay off the debt. When dealing with the debtor they are usually calm, professional and to a degree understanding; empathy is a very strong tool.
On the other hand placing a business debt with an agency escalates debt collection activities somewhat, but it’s no guarantee that a debtor will pay up. When learning how to collect a debt, know that the biggest single advantage is that if the matter is out of your hands (the business owner’s) so the owner is now free to work on more important things!
Creditors
Creditors are by far the easiest and cheapest source of additional funds – you simply don’t pay them! Unfortunately, scurrilous business operators can take this concept too far and they have no scruples whatsoever in burning their suppliers. Fortunately, such operators are few and far between, quickly earn a poor reputation, and run out of suppliers.
Creditors can be categorised as follows:
Suppliers essential to your ongoing business.
Suppliers not essential to your ongoing business where product/service can be readily sourced for the same price from competitors.
Bank or lending institution.
Tax department.
Each of the above need to be treated differently when you are in a tight cash flow position.
The first thing to remember is that your reputation is staked on your ability to pay your creditors. Word gets around very quickly when you don’t pay them and your ability to obtain credit, or further suppliers, is considerably compromised. So here are a few tips:
Pay all your creditors on time if you can. Your supplier will in turn look after you.
For exceptionally large bills, call your creditor and ask for payment over 2 to 3 months. Most creditors are happy to oblige providing you inform them! In fact, if informed in advance, they still consider you a good debtor.
Do not muck around with regular payment on your loans. You may lose creditability with your bank.
Do not be late with payments with IRD – it will cost you in significant amounts of interest.
However, if you get stuck there are a few options available:
there are companies that specialise in lending money to small business for payment of provisional taxes
call IRD and make arrangements – they will try to accommodate you
Increasing Sales
Increasing sales is one of the best ways to improve cash flow. Unfortunately, it comes with the downside that you have an immediate shortage of cash flow due to the lag between expenditure on increased sales and collecting the money from these sales. Rapid growth has been a nemesis for many businesses and most businesses can only grow as fast as cash flow allows that growth. To overcome cash shortages for rapid growth you can:
Plan ahead and retain profits before experiencing the growth spurt
Use a factoring company so that you get paid upon invoice
Borrow funds, find an investor or equity partner Increasing sales generally has the benefit of increasing the net margin since your overheads generally change little as sales increase – so you eventually catch up on shortages in cash.
Saving on Costs
There are a number of perspectives on saving costs. There is no doubt that reducing costs will improve profits and thus cash flows. However, there is a limit to which costs can be minimised without compromising the integrity of the business. If it gets to a point where costs cannot practically be reduced further and cash flows are getting worse then your business is in trouble. You have two options: either get out of the business, or reinvent the business to improve gross and thus net profits
All businesses should carefully examine their costs every year once the final accounts have been assembled. This is the basis of the budget which is then drafted and used to examine costs on a monthly basis.
How to Get Quick Cash
You are in trouble. You know that you need money to get the business through some difficult times due to a rapid growth spurt over the last couple of months. Although your debtors ledger has climbed significantly and you are owed plenty of money, you are struggling to pay your wages. How do you get cash quickly?
There are many options to overcome this problem and we have discussed most of these in the preceding articles. In summary, you can:
Borrow from family or friends. This should be treated as an arms length transaction and be fully documented and guaranteed as if it were a commercial loan. Avoid this option if you can – dangerous option when things go wrong!
Take a mortgage on your personal home. This is a cheap loan because you are paying interest at low rates compared with other loan options. Can normally organise within a week. Very easy if you have a flexiloan account
Borrow from a high risk money lender. Can be exceedingly expensive and may be difficult to find one who will lend quickly
Take a loan against assets – relatively quick and easy but usually dependent on a valuation. Business owners need to be reminded that the above are short term solutions only.
You may check your financial information monthly but are you doing enough? Do you create a cash flow chart? And have you established the cash flow goals for your business, both long and short term?