Cash flows are the life blood of business. They dictate when, how and if a business will survive, thrive or perish. A properly executed cash flow strategy can represent immense opportunities for growth. A poorly executed cash flow strategy can grind an otherwise profitable company to a screeching halt.
Managing working Capital
Working capital refers to the ability of an organisation to cover day-to-day expenses and short term debts. It’s like the air that fills your lungs; there must be a certain volume for your business to continue breathing.
If working capital isn’t properly understood, measured and planned for, then the potential impacts upon cash flow can be severe. Employee salaries and short term payables, for example, cannot be delayed and re-negotiated very easily (as opposed to a line of credit, for example) without directly affecting operations through bad employee morale, negative vendor relationships or potential legal repercussions.
Working capital cannot be understood through one measurement or ratio. It must be extensively analyzed through multiple perspectives because it is easily susceptible to distortion. Depending on your business, you may wish to consider also measuring working capital as a percentage of sales revenue and as a percentage of assets.
It’s also important to consider other measures that provide a a broader understanding of the working capital in your business, such as looking at the rate of inventory and accounts receivable turnover.
Regardless of which indicators you decide to use, working capital is best measured through multiple time frames. Comparing working capital on a monthly, quarterly and annual basis is usually a good starting point, however many businesses may require more frequent measurements.
Structuring Debt
Many loans are structured to require large payments at the end of the loan life. These loans are designed to allow your organization to have more working capital in the early stages of growth. In this scenario, you will have to plan very carefully to ensure that operations can provide sufficient cash flow to make these large payments on time.
One strategy is to set aside a reserve, where extra funds can be accumulated ahead of the scheduled payments. Or, it may be wiser to pursue a new loan to refinance the upcoming balloon payments and defer actual cash outflows until a later point in time.
If you’re relying on the latter strategy, time can either be your friend or your enemy. If you wait to begin loan negotiations too closely to the balloon payment date(s), you may not be able to refinance in time, or may end up accepting less favorable terms because of the pressure. This doesn’t just hurt the company’s bottom line and value for the stakeholders, but directly hurts the organization’s cash flow position.
In an even worse scenario, original financing may have been provided not by a bank, but by a private investment entity. In such cases, the loan may carry an option to convert outstanding balances into an ownership interest in the company if payments are not made on time.
Something like this can be very difficult to renegotiate with the original lender, as the original agreement will often allow for a purchase of ownership interest at very favorable terms to the original lender.
Managing Tax
In many ways, tax planning can be the hardest cash flow aspect for an organization to manage. It is simply the one where finance staff have the least control. You can’t change tax laws; you can only follow them.
There is a very clear distinction between losing tax credits and other cash outflows. For example, loans can be negotiated and upcoming changes in cash flows can be deferred until a future date when profits are higher.
This level of flexibility rarely exists with issues pertaining to tax. Because of this dynamic, tax planning becomes very much about legitimately reducing tax liabilities, whilst managing expectations and eliminating surprises. It becomes the job of the finance department to make sure that all relevant parties in operations are fully aware of possible budgetary changes well in advance.
Getting bad debts under control
A great number of businesses suffer from one problem; they find it difficult to predict and respond to customers not paying.
There are two ways to reduce the risk of bad debts. Firstly, traditional measures should be implemented by the CFO, such as;
- The implementation of credit checks and standards along side well thought out credit limits.
- A regular reassessment of customer credit worthiness
- Clearly defined payment terms and conditions
- Efficient internal procedures detailing policies relating to the collection of bad debts
- An efficient accounts receivable arm that will promptly follow up outstanding payments and adhere to internal collection policies.
It’s also vital to ensure that preparations are made for the non-collection of outstanding payments, not just by making accurate estimates, but by having sufficient cash flow reserves and revolving lines of credit to survive dips in cash inflows.
In addition to this, bad debts can be reduced through direct communication with elements inside the organization that have extensive knowledge of customers. In many instances, relying just on facts and figures in isolation is inefficient. Understanding the dynamics and situation of a customer will allow for a more accurate assessment of risk.