Managing your cashflow may seem daunting – but, equipped with the right tools, it doesn’t have to be. Here, we look at strategies to help your business improve its cashflow.
Why is cashflow important?
Businesses can be profitable but still fail. Meanwhile, businesses can be unprofitable and remain solvent for a period of time (but they won’t last forever).
In many respects, cashflow is more important than profitability. While the two go hand-in-hand, the speed at which money comes in and out of your business can be the difference between whether or not it can stay afloat.
Tools to manage your cashflow
Unless you are a start-up, your business should be aiming to be profitable. Developing a budget will help you determine whether a profit is likely to be achieved and break-even point.
Start by developing a budget and a break-even point analysis. Work out what your business’ fixed costs are, and an indication of what you can sell your product for, to calculate how much product you need to sell to reach break-even point.
Budgets are also a great tool to manage cashflow. For those of you in primary industries, you might set a budget and then experience a major weather event, changing the situation entirely – but we still recommend you do it.
Unless something has significantly changed in your business, last year’s actuals can be a good starting point. Tweak the budget on a monthly basis according to how your business is going.
Tip: Don’t prepare your budget with rose-coloured glasses. As we all know, a good season is just a rainfall event away, just as much as a bad season is only one hailstorm or drought event away. Shoot for what’s realistic. We recommend developing three budgets being a ‘base case’ – which is the status quo of the business and then developing ‘good season’ and ‘poor season’ budgets from the base case. Having the three scenarios in separate budgets helps you manage cashflow as the season unfolds.
‘3-way forecasting’ is a more advanced form of budgeting, which involves budgeting not just for cash flow, but for profitability and equity of the business. This is done in the form of the following:
- balance sheet
- profit and loss
- cashflow statement.
This gives a snapshot of a business’ performance and position as a result of an expected set of events (eg. lower sales volume, but higher margin). Banks are increasingly looking for this type of modelling as it can show that short term cash restrictions might simply be the result of higher levels of inventory or slower paying customers.
Understanding working capital is also critical to good cashflow management. It refers to the money needed to fund the normal, day-to-day operations of a business.
Working capital is effectively made up of: Stock on Hand + Debtors – Creditors.
Too little working capital can be detrimental to a business because you don’t have enough to satisfy your creditors. Similarly, too much working capital could mean the business is not using cash effectively – operating on a ‘lazy balance sheet’.
A working capital ratio is your current assets over your current liabilities, the assets you can realize within a 12-month period and your liabilities that need to be paid within a 12-month period.
Divide your current assets by your current liabilities to get your working capital ratio. In the finance world, a figure of between 1.2 – 2 times is considered a strong or reasonable working capital ratio. If your ratio is greater than two, that indicates a very solvent business. It might also, however, indicate there’s too much cash or stock potentially being used inefficiently.
Equally, if your ratio is below 1.2, it may be a short-term timing reason. If it’s regularly below 1.2, the business is likely suffering from a systemic cash flow problem which should be addressed as soon as possible.
Other tips to improve cashflow
Improving cashflow is the result of either increasing cash inflows or reducing cash outflows. While most horticultural producers have little bargaining power regarding sales prices (and therefore cash inflows), here are some tools you may enact in your business.
- Where product is forward commited to a customer, charge a deposit before starting the work to help cover some of the initial costs of completing the job.
- Offer discounts on early payment/upfront payment.
- Invoice throughout the job (don’t just wait until the end).
- Charge ‘administration fees’ to customers who continually pay late.
- Be proactive in collecting your debtors. Most customers don’t like receiving phone calls asking them to pay overdue invoices.
- Negotiate trade terms with suppliers.
- Take advantage of deferrals (i.e. BAS extensions & ATO payment plans). But be aware of the terms of these options and the ramifications of defaults.
These strategies are just some of the ways to help get your business’ cashflow on track for success.
Contact Rohan and the team at Bentleys for a no-obligation discussion:
07 3222 9726