How Australian SME’s can improve their cash flow. Now, of course, there are a variety of reasons why a business will suffer from a poor or weak cashflow and perhaps find itself in a position where its liquidity position is poor or weak. Perhaps the most important reason or cause of a cashflow problem is poor profitability or worse our business incurring losses. Other reasons we can also happen at the same time, of course, are that a business has invested in too much capacity has ever expanded. Perhaps also that it’s got excess working capital, for example, it may have allowed it stocks to rise too much, allowed its customers to take too long to pay outstanding bills or not taking enough credit from suppliers. Let’s have a look at some of these key issues in terms of how you might address them to improve the cash flow position of the business.
Essentially the answer lies in a combination of one or more of these things on the screen there. Firstly, and this is always a key point to make an exam, a business if it wants to manage its cashflow better and improve the cash flow position needs to start doing some reliable and more effective cashflow. Forecasting is a key management technique. Second, it needs to do everything it can to keep costs under control because losses or low profits are the main cause of poor cashflow. Then it needs to look at all aspects of the way it manages working capital. And we’ll look at two or three areas of this next. And finally, of course, if it’s got a cash flow problem that might indicate that it’s got the wrong kinds of finance, the wrong sources of finance. So that might be the moment to have a look again at the different mix of finance that the business uses.
Why Working Capital
Let’s look first at working capital because this is often the short term fix to a cashflow problem. Don’t forget that a business needs to invest. It finances managing the activities of the business. For example, if it’s a manufacturer or retailer, it will need to invest in inventories or stocks. Most businesses also allow customers to take time to pay their debts, trade debtors or trade receivables.
But on the other hand, of course, a business can also take some time to pay its suppliers. Trade creditors or trade payables is a source of finance, and you add the stocks and the debtors and the creditors together, and that gives you the working capital, how much cash is tied up in working capital. So clearly, therefore, there are some things that could be done to improve the working capital position and therefore improve the cashflow. Just looking at stocks or inventories as that otherwise known a business that has a lot of capital invested in stocks or inventories is quite likely to suffer from cash flow problems if the level of stocks is inappropriate for the business.
So it should be looking at how much stock it’s holding in the warehouse or within the production system and seeing whether it could reduce stocks because by reducing stocks, that should free up some cash back to the business. Now, of course, as you use, as you will have seen when we looked at stock management, it’s a difficult balance, isn’t it? To get right. On the one hand, you want to make sure you don’t hold too much stock, but on the other hand, you want to make sure you’ve got enough to be able to handle the demand that the business didn’t want. The business wants to, uh, to turn into sales. So managing stocks is tricky and we’ve produced a separate revision, a video on how to manage stocks effectively. Amounts owed by customers is another area where a business can quickly or quite quickly improve its cash flow position in particular by implementing what’s known as credit control.
Learn about invoice factoring
This is the way in which your business manages how much is owed to it by its customers — these trade debtors. And there’s a whole bunch of things that can be done particularly around better administration and better risk management that enables the business to keep a title lid on the amount that’s owed by customers and how long they pay. Now don’t forget, of course, there is a key ratio to look at there, the trade receivables or trade desk days as a key indicator as to how well the business is managing, how much is owed by its customers. Um, you may have come across this concept, let’s mention it briefly, debt factoring. This is a short term fix that a business or some businesses can use to release the capital that’s tied up in trade debtors back into the businesses cash. What happens here is that the business effectively sells its debts, sells its outstanding invoices to a finance company or something as a factoring company.
And that third party business then owns that debt and goes ahead and tries to recover it. So the cash flow benefit is obvious that you get the money or a proportion of the money into the business, but of course, you pay the price for that, a high a fee or interest cost or premium on that which the debt factoring company includes as part of its profits. So debt factoring is potentially a, an effective way of reducing the amount owed by your customers. But of course, it has a cost. Looking at suppliers, when we’ve looked at a trade payable days and the uh, the ratios around supplier payments, we’ve seen that our business can effectively improve its cash flow by taking longer to pay its suppliers. In other words, by increasing the number of trade credits. Trade credit is the amounts owed to suppliers for goods and services which are being provided but have not yet been settled when it comes to paying the bill.
Now, of course, you can see that by delaying payment, that should leave more cash in the bank. But of course, the risk with all of this is that by not paying it, you damage your relationships with your C key suppliers, but also potentially they take, take it to court for nonpayment. However, improving or extending the amount of time that you take to pay your key suppliers is an effective way, albeit not a longterm way of improving a cashflow position. Of course, just look at this a little bit more broadly though. We just need to think more widely about what the underlying causes might be of the cashflow problems. So we’ve already said that in the short term there’s a bunch of things you can do to try to cut costs, to reduce the amount that you’ve got to invest in stocks and debtors, perhaps to delay payments to your suppliers, uh, to, uh, to keep the cash in the bank for longer.
And of course, it’s possible you may even have some surplus on, uh, unused assets in the business that you can turn into cash. However, in the longer term, I think a key point to make is to, to suggest that they pour cashflow position may be indicative of a poor capitalization and the business, the business doesn’t have the right kinds of sources of finance. So in the longer term, you will be looking at whether or not the business needs to raise new equity finance through the sale of shares or perhaps longer-term loans or borings. For example, long longterm bank loans or debentures as a way of providing a business with a more secure longterm financing situation, But what we’ve done though is just giving you an overview of the key ways in which your business can improve its cash flow.