This is according to Lionel Billings, head of national consulting services at Business Partner Limited, a risk finance company for formal SMEs in South Africa and selected African countries. He adds that given the challenging economic environment that SMEs currently operate in, it is crucial that business owners know how to manage their cash flow effectively – now more than ever.
According to Billings, businesses need to differentiate between profit and cash flow.
“Many businesses are profitable, yet run out of money due to ineffective cash flow management,” says Billings. “Many businesses generate substantial profit during a month as a result of orders or sales, but as payment often isn’t due for another 30 or 60 days, business owners sometimes find themselves in a situation where they do not have sufficient cash flow to continue operating, as they are unable to produce products or pay staff salaries.”
He explains that for businesses to avoid finding themselves in this situation, owners need to be aware of a few key areas that could result in cash flow problems.
“One area is credit control. It is crucial to have strict credit policies in place, as poor credit control can result in a business not receiving payment on time and in turn, could lead to the business defaulting on its obligations. It is also important to remember that larger enterprises often take longer to process invoices, which sometimes needs to be taken into account as late payment can have a drastic effect on SMEs.”
Billings says that order fulfilment is another area that business owners need to be aware of. “If a business doesn’t deliver its products or services on time, the invoice will not be paid. To avoid over promising to clients, a business’ workload needs to be planned properly.”
He adds that other factors that could lead to cash flow problems include inefficient ordering systems, poor management accounting, inadequate supplier management and lack of control over gross profits or overheads.
In addition, Billings says that the essence of successful cash flow management is the regulation of all money flowing in and out of a business. “An increased, consistent cash flow will create a predictable business pattern, making it easier for a business to plan and budget for future growth.”
Nine tips to increase cash flow
Billings offers the following tips to business owners on how to manage and increase their cash flow:
1. Stretch out payables: Take the maximum amount of time assigned to pay suppliers, as this will result in interest-free credit for the business.
2. Take advantage of early payment incentives: If you have cash available, take advantage of the discounts offered by suppliers, as a 2% discount on a 30-day invoice is equal to a 24% annual return if the money was invested. Also, enquire with all your suppliers as to whether they can offer a discount.
3. Balance your client base: Many service and professional companies, for example, accounts, work with certain clients on a project-by-project basis. Instead, rather try and convert these clients to a retainer relationship by offering some kind of incentive or value-added service. While this may reduce profit margins, it will make cash flow more predictable.
4. Check your pricing: Review your prices regularly in order to ensure that they are aligned with rising costs. Ensure you also monitor your competition on a consistent basis, as if they are charging higher prices, then perhaps you should too.
5. Form a buying cooperative: Do joint buying and buy in bulk with colleagues and/or other businesses in order to save on the products purchased.
6. Renegotiate insurance and supplier policies: Review insurance policies annually and regularly examine bills to ensure you are getting the best possible deal. Ensure that you keep a close eye on price sensitive services, such as internet access, as these can often change.
7. Tighten your stock: Reduce overstocking by calculating your business’s inventory turnover ratio (cost of goods sold divided by the average value of your inventory) and compare this with the industry norm. Also ensure that you periodically check inventory for old or outdated stock and either defer upcoming orders to use that stock or sell it at cost to improve liquidity.
8. Consider leasing instead of buying: Leasing generally costs more than buying, but these costs can often be justified by the cash flow benefits. Lease payments also have a tax benefit as they can be claimed as a business expense.
9. Stick to a budget: It goes without saying – don’t overspend.