Monitoring cash flow should be your number one priority if you are a business owner. After all, cash is king. Part of this process involves having careful control of debtors. For anyone that has experienced periods of tight monetary control, you know how critical this is in tough times.
Outlined below are key points on how to ensure your cash flow is always top of mind and properly managed – in good times and bad:
1. Obtaining interest-free credit
The cheapest form of finance is often supplied by your suppliers and creditors. Generally you can get 30 to 60 days credit interest free. Of course, the reverse is true when you are the supplier and therefore giving interest free money to your customers.
2. Be prepared for rising interest rates
Interest rates are currently at historical lows and whilst they look set to say there for the near future, rises are inevitable so you need to be prepared. In the current low interest rate climate you should ensure that you have appropriate policies and practices in place that will ensure that you can survive the eventual interest rate rises.
3. Monitor debtors payment patterns
Insolvency practitioners list major bad debts as one of the main causes of business failures. Your focus should always be on your cash flow no matter how well the business is doing with particular attention being paid to your debtors.
It is not always obvious which debtor has become a greater risk to you. An important review tool is to monitor the terms of payment of all debtors, and to act immediately if you detect a change in payment patterns as this could be an issue with their cash flow which will have a knock on effect on yours.
4. Watch out for customers
It’s not just debtors that you have to monitor – a trusted customer who has always paid within your normal trading terms could miss a payment date and ask for an extension. You could be tempted to give some leeway but in tight financial times this is the wrong thing to do. Instead, contact your customer immediately to determine the reason and don’t be afraid to demand payment. If the slowing of payments continues you should seriously consider whether it is prudent to continue trading with this customer.
To put this in perspective, imagine a customer who owes $100,000 and becomes insolvent causing you to suffer a double loss. If you are working on a gross profit margin of 40%, it will take a sale of $250,000 to recover the $100,000 loss. Not an easy feat.
5. Take stock
Despite the lower interest rates on offer at the moment you should resist the temptation to ‘stock up’. Too much stock places strain on cash resources – you need to have enough stock to supply customers but resist holding quantities that may take months to sell (just look at Dick Smith).
Stock requirements are driven by sales, it’s great to be optimistic but you have to be realistic when it comes to sales forecasts – buy stock on likely sales rather than on what you would like to achieve.
Be careful accepting discounts for bulk deals as well, the product maybe cheaper but it will remain in stock longer and require more cash resources.
It’s also worth considering that if your supplier payment terms are to pay in full by the end of the month, it’s best to purchase early in the month rather than late in the previous month.
6. Is it time to fix it?
Now could be a good time to consider fixing interest rates but be aware that if you are planning to exit a fixed rate facility, it often comes with penalties. It may sound like common sense but if you’re planning on selling your business in three years do not fix rates for five years.
In conclusion, debtors and stock control should always be a priority and the practices that you learn and use during the tight times should not be relaxed when economic conditions improve. Tough economic times are never fun but the lessons you learn can be used to your advantage in more profitable times.
About the author
Des Caulfield is Director at MGI Adelaide. With more than 40 years experience in the accounting profession, he has extensive knowledge and understanding of the issues faced by businesses across a diverse array of industries and sectors. He has a particular interest in the family and privately owned business sector, consulting to a wide range of clients on issues such as taxation and estate planning, succession planning, business sales and acquisitions.