24 Jun Speed Up The Cash Flow In Your SME Business
Speed Up The Cash Flow In Your SME Business.
How many times have we seen so-called “profitable” SME businesses go to the wall? It happens every day in fact. Perhaps it is because some SME business owners simply don’t appreciate the difference between profit and cash. If you get paid in cash, you can recognize the profit immediately, and be in a position to make payments to suppliers or pay for business overheads. Cash flow is King in any business.
If the sale is on credit, you need to wait until you have received payment and it gets cleared through your bank before you can recognize the profit. Until this clearance takes place, you have not in fact made a profit and there remains a risk that you could make a loss. This delay in receiving payment means that you may not be in a position to make payments that may be due to your creditors.
SME businesses usually fail because they run out of cash and not because they are unprofitable. Therefore, it is incumbent on a business to carefully manage its cash position and to develop an understanding of its own unique cash conversion cycle. This is made up of the sales cycle, the production/inventory cycle, the delivery cycle, and the billing/payment cycle.
This cash conversion cycle measures how long it takes a dollar or a euro spent on anything in the business, to make its way through the business, and to come out the far side and become available for further spending or investment. This initial dollar or euro can be spent on anything from buying inventory, to production expenses, to paying employees, to general overhead.
The real challenge comes when you are trying to grow your business and you are relying on the business’s cash generating capabilities to fund the growth. Without external funding, it may simply be impossible to grow at the rate you desire. Profitable companies that attempt to grow too fast inevitably run out of cash. This is often referred to as overtrading.
The trick is to be able to calculate a sustainable growth rate that allows you to balance the rate you spend cash with the rate that you generate cash. Otherwise, you are going to need a working capital loan or additional equity funding to fuel the growth.
It is in fact possible to work our precisely how long a business’s cash conversion cycle is and what its self-financeable growth rate is. A Harvard Business Review article by Neil C. Churchill and John W. Mullins offers a simple method for calculating the self-financeable growth rate per cycle or per annum and this article may be accessed here https://hbr.org/2001/05/how-fast-can-your-company-afford-to-grow
So how can you improve your cash conversion cycle?
The three main levers are:
- Speed up cash flow by reducing accounts receivable days, or by reducing inventory days.
- Reduce your costs
- Raise your prices
There may be accepted levels of credit days granted in your industry, and some customers may try to abuse this by extending the payment until it suits their own cash flow. There is nothing to stop you discussing payment terms with your customers and seeking more equitable terms. If you don’t ask for better terms, or push to have the existing terms observed, it won’t happen on its own.
If you have a products based business, you can try to reduce the amount of inventory/stock you have sitting in your storage facility at any one time. Perhaps you can look for more frequent delivery from your suppliers and therefore you will only be paying for inventory as it is needed. This frees up cash to be spent in other areas.
If you can find a way to reduce your costs by a percentage point or two, it will generate increased profits, which will in turn increase available cash flow. Similarly, raising prices a little bit will increase profits, if this can be done without losing business, and this too will result in increased cash flow through the business.
In SME businesses, cash flow needs to remain front and center and the accounts department needs to produce a daily cash report for the CEO, which shows the bank position as well as all movements in and out of the bank account in the past 24 hours, with a particular emphasis on accounts receivable/debtors and accounts payable/creditors. This should be accompanied by a rolling 30-day cash flow projection. This is an essential way to retain control of finances in your SME business.
Click on the link below right now to view the full version of this article and to discover some other ways to improve cash flow in your SME business