Cash flow problems? 8 important things to review and optimise right now

Neglecting cash flow is one of the key causes of small business failure. If your business is struggling with cash flow, it’s time to look into these eight important areas to get things back on track, writes Brad Turville, Virtual CFO at BJT Financial.

Cash flow is the lifeblood of every business, big and small, yet many struggle with cash flow problems. Sometimes you are flush with cash, other times you are stressing out over how to make rent and payroll.

There can be confusion around why your profit is one number, yet your cash at bank is a completely different number.

Eight ways to deal with cashflow problems

Considering that neglecting your cash flows is one of the top causes of business failure, I have below detailed eight areas that can contribute to poor cash flow:

1. Accounts receivable

When you create an invoice for a customer but they haven’t paid it yet, this dollar amount sits outstanding in your Accounts Receivable.

You may have payment terms of 30 days, meaning you expect the invoice to be paid within 30 days time, but more commonly I see the actual average payment days being well over 30. As a rough guide, for a business doing $500,000 per annum in sales, every one day over your 30 day terms equates to $1,370 in cash tied up.

For businesses that get paid on an invoice (versus payment through a cash register or online shopping cart), your Accounts Receivable would be the first place to look for cash locked up that is overdue.

Tips to manage accounts receivable:

1. Call/email/mail/text all customers that are outside your payment terms and request payment.
2. Offer multiple payment methods. For example cash, EFTPOS, credit card, fee funding.
3. Consider a payment plan for those that cannot pay the full amount now – you’d rather start receiving something than nothing.
4. Stop work for those that can’t or won’t pay or cooperate.
5. Hand to a lawyer/debt collector as a last resort.

2. Inventory / Work in progress

Inventory is stock you have purchased that you have on the shelf or in the warehouse that hasn’t sold yet. Another way to look at this is cash sitting on a shelf that once sold, goes into your bank.

You need to hold a certain amount of stock and a range of products to service orders. You don’t want to hold too little stock, as that can impact customer experience if what they want is not available. On the other hand, holding too much inventory will impact free cash flow.

Work in Progress (WIP) is the record of time/cost of a job that you haven’t completed and invoiced for yet. This is common in service-based businesses. Many sit on too much WIP without getting it invoiced.

Tips to manage inventory/work in progress:

1. Work with your accountant or advisor to calculate your Stock Turn Days and closely manage inventory levels (the same goes for WIP Days).
2. Plan ahead to get an understanding of required inventory levels if you have a growing business.
3. Invoice WIP more regularly through progress invoices. Don’t wait until the end of week or end of month to invoice – if you finish a job today, get the invoice out today. Don’t wait!

3. Accounts payable

When you receive an invoice from a supplier, this is entered into your accounting system and it sits there as an Accounts Payable – meaning you’ve received and processed the invoice, it just needs to be paid. But the supplier might give you 45 days to pay them. It is important to use your accounting software to manage the receipt, processing and due date for payable invoices.

A problem I commonly see is businesses just pay suppliers when they receive the invoice. The lost opportunity here is that if they give you 45 days to pay, you want to take 45 days because you can put that cash to better use in the meantime. You also don’t want to pay suppliers really late and upset those relationships.

Tips to manage accounts payable:

1. Use accounting software such as Xero, QBO, etc. to manage accounts payable.
2. Pay bills as close to their due date as possible – don’t pay on receipt if they extend you payment terms.
3. As your business grows you can move to a twice per month pay run, say the 15th and 30th of the month.

4. Drawings

Taking cash from your business for your own personal usage is a common cash drain. I’ve previously written on ‘how to pay yourself’ but what I commonly see is business owners taking cash when they need it, in dribs and drabs. This builds up over time and in many cases, business owners are shocked at how much cash they have been taking.

That said, you still need to put food on the table so get clear on what your cash drawings are per fortnight/month, and better yet, start paying yourself a salary.

Tips to manage drawings:

1. Pay yourself a regular salary. This may be a smaller amount in the earlier days of the business as you juggle cash flows to get it up and running.
2. Decide on a policy of paying yourself a dividend each quarter/year.
3. Work with your accountant on both above points to best structure for tax purposes and maintain sufficient business cash flow.

5. Financing

Financing comes in many forms, including shareholders putting cash into the business, a loan or overdraft from the bank, or external investors buying shares or loaning funds.

To grow a business – particularly to grow fast – or acquire another business, or stock up for an upcoming busy trade period, you require outgoings of cash upfront before receiving back a greater upside. That cash has to come from somewhere.

If incorrectly funded, or if a business doesn’t produce strong organic cash flows, its speed of growth or ability to take advantage of opportunities will be restricted to the cash available.

It is important to get clear on whether funding is required, what type, and from whom. This is not to be confused with accessing finance because you have poor cash flow management.

Tips to manage financing:

1. Fix your own cash flow management. If you have holes in the bucket, adding more water will just escape out the holes, so fix them first.
2. Get clear on your working capital requirements in your business, including relevant liquidity ratios, such as current ratio and quick ratio.
3. Plan out how much financing is required, what type, and how it will help you achieve your objectives.

6. Sales

Sometimes the reason a business has tight cash flow is because you simply aren’t making enough sales.

You will have a certain amount of fixed expenses in your business, such as marketing, rent, staff, telephone, internet, accounting, legals, etc. If you only have enough revenue to just break even, this will result in poor cash flow.

Tips to manage sales:

1. Get clear on your marketing and sales plan that will drive the growth in your business.
2. Create an annual budget of sales and expenses, and set a weekly sales KPI to track and manage (i.e. what $ of sales do we need to do each week?).
3. Hire a sales person and remunerate and reward to drive this department of your business.

7. Gross margin

Your business is making sales, however we need to consider the costs required to make those sales.

Your gross margin (also called gross profit) is calculated as follows: Sales – Cost Of Sales = Gross Margin.

Two types of examples:

1. You sell a widget for $75 that cost you $40 to purchase, your gross margin is $35 or 46.67%.
2. You provide a service to a client for $1,000 and the direct wages required to deliver that service cost $400, your gross margin is $600 or 60%.

Your gross margin is more of a true indicator of profit on a sale, after factoring in the cost. A really low gross margin will require a large volume of sales to generate sufficient profits to cover overheads.

Tips to manage gross margin:

1. Refer to the above section on Sales.
2. Closely monitor your Cost of Sales or Direct Wages. You might be paying a premium to get stock air freighted to your warehouse ,or you have low-productive team members that increase the costs and reduce the margin on each job.
3. Review your pricing – this is a powerful lever in improving gross margins.

8. Expenses

Every business incurs a range of different expenses required to keep it operating. In fact, some expenses are very important to the operation and growth of the business, such as effective marketing and advertising.

With that said, wastage and overspending can find its way into your business.

A common example is monthly subscriptions that can quickly add up. I’ve worked with a business whose telecommunications expenses looked outrageously high – I engaged an expert in that space to review and they came back with a package half the price, receiving exactly the same specifications.

Tips to manage expenses:

1. Go through your expenses line by line and review. Get second opinions or shop around.
2. Don’t just cut expenses to increase profits – some expenses are critical to the operation and growth of the business.
3. Work with your accountant and bookkeeper to best structure a chart of accounts in your business’ accounting software. All too often I see a basic set of accounts, and each expense line item has a whole array of different expenses lumped into it (e.g. all different types of marketing expenditure lumped under the one marketing expense item).

High cash usage is one of the top reasons a business will struggle or go under, so it deserves a certain level of respect and management.

In my world, I always start with cash flow: where is cash being wasted, where are the cash bottlenecks, and what future cash flows look like.

Not only are strong cash flows a great ingredient for running a great business, but investors like buying and investing in businesses that have strong cash flows.

Use the insights and tips in this article to look at your own business closely, determine where you can improve, and then go and implement.

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