In an earlier article "Cash is King" -see it here- I focussed on the importance of managing your debtor collection. Of course cash management in its wider sense is of critical importance to the survival and progression of your business. It is the lack of cash that will lead to the failure of a business. In my role as an adviser to small-medium businesses over many years now, cash - or lack of it - tells me almost everything I need to know about a business. A problem with cash can be a result of poor management of debtors, bad debts, inadequate margins, overhead expenses out of line with the size of the business, declining sales, etc. - or a combination of several. It can also be a as a result of increasing sales maybe even leading to an increase in profitability - at least theoretically - but the fact that the increased sales will almost certainly lead to a higher level of debtors and inventory to be financed is what I would like to focus on in this note.
Cash is something that needs to be thought about from the beginning - effective management of cash needs to be built into your business model. Consider the cash cycle of the following business:
| Annual Sales | $1,500,000 |
| Average daily sales | $4,110 |
| Cash cycle calculation: | |
| Average time taken to collect payment from customers | 40 days1 |
| | plus |
| Average days sales held in stock | 35 days |
| | less |
| Average days taken to pay suppliers | 30 days |
| | Equals: |
| Cash Cycle | 45 days |
| Funding required ($4,110 X 45) | $185,000 |
Note 1: NZ average for 2013 was 39.6
You can do your own calculation for your business but be aware that the calculation ignores spikes such as for gst payments and it also ignores that a one off delay by a debtor will also have an impact. It also assumes sales are evenly spread throughout the year which is not always the case. You can also see that if sales double to $3,000,000 then your cash requirement also doubles and if that is not available then the business will be headed for trouble. If you are an importer and you need to provide your supplier with a Letter of Credit (thus utilizing bank funding lines) then your effective cash cycle will be commensurately longer. The above is a bit theoretical of course but it gives a guide - in the example an ongoing funding need of $185,000 is needed to adequately fund the business. This can be provided by you in cash or from retained profits... or it can be borrowed either from a bank or finance company.
There is an increasing trend towards debtor - or invoice - finance these days and an expert in this field is New Zealand owned and operated Lock Finance. This type of finance gives access to up to 80/90% of debtors within a day or two of the invoice being issued and a big advantage is that the funding increases as the size of the business increases.
A more detailed approach to establishing your cash needs is almost always warranted so that you can be a bit more definitive about the business' cash needs. This would involve producing a budgeted monthly profit and loss for the period and overlaying that with your own specific cash drivers so that a monthly cash flow forecast and projected monthly balance sheets can be produced. Your accountant or adviser should be able to help you with this and it is also a field in which I specialise.
I cannot emphasise strongly enough how important understanding the business cash cycle and the careful management of the cash in your business is - so many good businesses have failed over the years for lack of attention to this basic principle.
Peter Ryan
Peter Ryan is an experienced former commercial banker. For the last 15 years he has operated his own business which specialises in helping small and medium businesses increase their profitability, improve their cash flow management, and generally assisting them to make more money.
Phone 0800 723476
peter@helpforbusiness.co.nz
www.helpforbusiness.co.nz