Improving the financial health of your business is more than just getting more clients or more sales across the line – In some cases, growth can actually elicit problems in the business, especially if cash flow isn’t managed properly – Christine Christian takes us through simple steps to help manage cash flow and mitigate risk
Cash flow is the lifeblood of every business. Current estimates indicate that approximately 90 percent of business failures are the result of poor cash flow and debt management practices. However many business owners remain unaware of these impacts or how to prevent them.
The lag between the provision of a product or service and receipt of payment can cause significant problems. Bad payers considerably reduce business cash flow, draining the funds that are required for the day-to-day running of operations or could be used for growth. In addition, bad payers are a drain on internal resources as staff are required to recover overdue amounts or are pushed to increase sales to make up the shortfall.
Dun & Bradstreet’s (D&B) data reveals that business-to-business (B2B) trade payments have been at alarmingly high levels since the introduction of the GST in 2000. Over the last seven years, businesses have averaged 54.5 days to pay accounts—a peak of 63.5 days occurred in 2000 and a low of 48.8 in 2004, with steady increases following since.
While the extension of credit is a necessary part of running a business, owners and managers need to be rigorous about ensuring that they have solid cash flow management and risk mitigation processes in place so they can stay in business and ahead of the pack.
In its most simple form, cash flow management means delaying outlays for as long as possible while encouraging anyone who owes you money to pay as rapidly as possible.
An effective cash flow process requires the preparation of cash flow projections at least quarterly, if not more frequently. While this may seem like a timely undertaking, an accurate cash flow projection will alert you to trouble before it occurs—it is one of the most important things a business can do.
A cash flow projection needs to account for both incomings and outgoings. How much cash is the business going to get in and pay out, and when will these actions take place? When drawing up a cash flow projection it is important to identify both set and variable costs, and to take into account customers’ payment histories as these items will influence the amount and timing of incoming and outgoing funds.
Shortfalls and seasonal fluctuations also need to be considered. A business should be quite aware of periods where sales are likely to be slow or customers are more likely to pay late, such as Christmas. Be sure that you have enough cash on hand during these periods to cover inflexible business costs such as wages.
Acquiring an accurate insight into the customer’s financial health and debt paying behaviour is also critical to the ongoing viability of your business. Understanding the ability of a customer to pay, and their propensity to pay within the specified credit parameters, is an essential part of the risk mitigation process. To achieve the required level of understanding, smart business operators are increasingly utilising simple credit checking processes.
This process should be undertaken prior to the extension of credit and it must occur regardless of the size of the business that is seeking to obtain your product or service. The size of an organisation cannot be assumed to correlate with its payment behaviour.
As part of this process, businesses must be prepared to turn potential customers away. The loss of a sale is much more manageable for business executives than a persistently delinquent payer that negatively impacts cash flow and spreads resources thin as the business seeks to recoup the outstanding monies.
Existing customers should also be investigated as there may be bad payers among them.
When conducting a credit check it is important that all defaults are considered. Traditionally, low value amounts (below $500) or no-bank credit have been considered less important when assessing credit applications and risk. However, research conducted by D&B reveals the importance of this data by demonstrating that those who default on non-bank credit and low value amounts are in fact, a higher risk of defaulting on larger amounts and traditional credit types.
D&B research also shows the increasing propensity of Australian consumers to default on smaller amounts of debt. In the first half of this year, almost half (47 percent) of all consumer debt referred to D&B was for amounts of less than $400.
This trend puts a significant amount of pressure on business cash flow. Despite the dollar value of the debt being small, the individual monies owed can add up to a significant amount of money, particularly for small businesses.
Implementing a credit checking process has many benefits, but it does not guarantee that debtors will pay their accounts on time. Accordingly, the onus is on business to ensure it has solid receivables processes in place.
An efficient receivables process is characterised by:
• the establishment of clear credit terms at the outset of a relationship,
• prompt issuance of invoices,
• tracking of accounts receivable to identify slow-paying customers,
• regular communication with customers to identify and resolve problems before invoices become overdue, and
• action taken against a debtor if they are persistently delinquent.
Not all businesses have the capability or capacity to manage the accounts receivable process internally. This is frequently the case for SMEs, who often try to be everything to everyone. To be successful in business, it is important to recognise when external help is required. Don’t be afraid to utilise the services of professionals by outsourcing the debt to a reputable collector.
Managing payables also forms an important part of cash flow management. Particularly when a company is growing and sales are expanding, executives need to be conscious not to take their eye off the ball—business growth often creates a false sense of security. During these periods, expenses need to be closely monitored and controlled to ensure that they don’t grow faster than sales. In addition, a business should take advantage of the payment terms of its accounts and hold on to the money until the invoice has to be paid.
From time to time, a business will require funding either to help it survive a cash shortfall or to fund business growth. There are a huge variety of finance products available to businesses, including: overdrafts, premium funding, lease facilities and credit cards. When seeking finance it is important to ensure that you select an appropriate source of funding for your requirements and that you can pay the debt before the interest kicks in.
Having a more complete picture of your business incomings and outgoings, and a better understanding of your customers financial health will assist the business to free up funds for growth. As well, it will save a significant number of businesses from failure.
* Christine Christian is CEO of Dun & Bradstreet Australia, a leader in credit reporting, business intelligence and collections.