Why Is Cash Flow Important?

It’s no secret that cash flow is important to a business and we’ve all heard lots of cash flow sayings. Something around revenue being Vanity, profit being Sanity but ultimately cash is King. We all know that makes perfect sense but ask yourself how many times do you do everything possible to improve the cash flow situation in your business?

The Value Of A Positive Cash Flow

A positive cash flow has real value in a business.  It enables you to:

  • settle debts at a time of your choosing;
  • invest in the business – on things such as equipment, buildings, acquisitions;
  • return money to shareholders;
  • pay your expenses when they are due, building up goodwill with suppliers;
  • and build up that rainy-day fund.

Another value of having a positive cash flow is that should you decide to sell out, a cash positive business will attract a higher profit multiple compared to one that is more like a cash drain.

From a buyers point of view, if the business is not cash positive then they will have to put additional cash into the business once they’ve bought it and this will reduce the value they want to pay you for the business. This is what I call the valuation see-saw.  Buying a business cheaply with poor cashflow often means putting more in once you’ve bought it. Buying a cash positive business often means paying premium for it but having to put little in to working capital.

What’s your valuation see-saw score?

The Value Builder Score questionnaire takes 13 minutes to do and you will instantly get your score out of 100. Companies with a score of 80+ typically get offers that are 71% higher than average scoring businesses. Work out your valuation see-saw score here

The Profit And Cash Generating Engine

Imagine your business as a profit and cash generating engine, using fixed assets, stock, people, services and cash (usually with cash tied up with debtors or committed to creditors). All those parts of the engine add up to give a net asset value for the business.

The more profit and cash the engine can generate, then the more attractive it is to a buyer. Your task as the business owner is to maximise the use of your net assets.

Keeping with the engine analogy:

  • think of the net asset / cash relationship like your power to weight ratio. A well-managed net asset base will have a better ratio and be more valuable;
  • an electric engine produces immediate power on demand – watch those videos of Tesla’s racing against dragsters. Whereas an internal combustion engine, especially one with a poor turbo, will have a delay in delivering power. If your business produces cash more like a Tesla rather than like a turbo lag, then it will be more valuable.

How To Improve Cash Flow

Let’s pick off a few key areas to focus on that help that power to weight ratio and avoid a turbo lag:

Sales and Debtors

Cash flow management starts before the sale is made. Why wouldn’t you always do a credit check on new prospective customers? Knowing their credit history and limits will help you negotiate the payment terms that are often part of the sale negotiation.

I’ve come across numerous situations where the first few transactions are payment up front before moving onto a credit account arrangement.  Even if terms aren’t core to the negotiation, it is still important to get that clarity – pointing out the key points of your terms and conditions.

If you’ve just thought to yourself, ‘I don’t have standard T&Cs’, then get your solicitor to help you draft a set that suits your business. Please don’t just download one from the web and change the titles!

I remember in an earlier part of my career I had responsibility for managing the company’s B2B relationships. For the really big customers, who were paying £millions each year, we sometimes had production or quality issues. As always happens when big customers shout, everything else gets dropped and people throw themselves into sorting things out. In my experience it’s inefficient and stressful!

To solve these problems we decided to set up key account teams. Members of those teams met their customer contacts to agree a range of operating procedures, including our credit control person meeting the customers’ finance or payments person. Over time we ironed out operating and financial procedures and those big-customer ‘shouts’ became a thing of the past.

Part of the ‘nitty gritty’ of the procedures that we ironed out was to agree the paperwork needed to get payments approved. Yes, that might sound simple, but how many times have you been asked to quote a customer’s purchase order number on your invoice? Or, provide a proof of delivery or service completion? Simple things that can easily delay cash receipts.

The clarity of procedures includes regular communication with your customer’s finance team – sending statements, agreeing what has been paid and is outstanding.

Remember, these things don’t just help you, they help your supplier.

Your accounting system should give you a selection of debtor listings and aged debt reports that help you keep on track of timely and slow payers.

Unfortunately, things can go bad when a customer doesn’t meet the agreed credit arrangements. The theme of clarity of process still follows – knowing the format and timing of chasing, legal and debt recovery actions is important. Don’t make them up each time there is a late payment.

I don’t intend this blog to be a full summary of all options to help debtor cash management but please don’t forget:

  • Early payment discounts as an option – I don’t see much of it in practice as interest rates have been low for so long;
  • Charging interest on late payments – How many SME’s do that with their larger customers?
  • Invoice discounting and factoring – obviously helps cash flow as most of the outstanding debt can be drawn down earlier than your normal credit period. Bear in mind that early cash comes with a fee and a contractual commitment. These arrangements can be helpful for some fast-growing businesses but its best to speak to a specialist provider including your bank.

Creditors and Payments

Many of the approaches for debtors can be applied to your creditors. Being a predictable payer builds trust with your suppliers. Should you have difficulties now and again, you can call on that trust and goodwill by asking for extra time to pay.

Cashflow Forecast

A final thought, one that is not always done, but is probably one of the most critical tools for a growing business – do some form of cashflow forecast. How many stories have we all heard about profitable businesses going under because they ran out of cash? I know a car retail business that did weekly forecasts, broken down by day, because the funding providers wanted to know the details – the timing of a car sale can affect cash balances by £20-£70k in one transaction.

Think ahead – when is your next VAT payment or other tax payment is due, or when do you have significant receipt or payment due?

Cash flow is never far from a business owners thoughts. But it’s never about past cash flows, it’s always about what could happen in the future. Whether it’s chasing a debt or deciding when to pay a supplier. We all agree that cash really is King. So, we should apply clear processes for managing our receipts and payments and importantly, forecasting how those future flows will impact the business

Should you be thinking about selling your business, then think about making your cash engine really efficient, with immediate power on demand.  And if you want to work out your valuation see-saw score click here.

 

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