Many business owners are driven by a desire to increase the top line (turnover) and lose sight of profitability, and more importantly cash flow. Sometimes this often reckless ambition can result in the ultimate failure of the business even when on the face of it the business is very busy.
Don’t get me wrong, increasing turnover should be a main objective of any business but it should be part of a sound business strategy which also plans for increased profitability and managed cash flow.
Lack of cash flow is often the main reason that a business fails and it is important to have an understanding as to the reasons why cash runs out even in businesses that are continuing to show growth.
Customer debts – as turnover increases then the volume of customer debt is likely to increase. The effect of this is heightened when customers exceed their credit terms or do not pay at all. The risk to cash flow further increases where there are one or two large customers and the value of their debt becomes a large proportion of the overall sum.
Stock – in times of growth it is easy to lose control over stock levels, or to purchase large bulk quantities in order to take advantage of discounts. However this stock will need to be paid for often some time before the business receives the proceeds from the sale of the stock.
Staffing levels – in particular where large contracts are won, there can be a requirement to increase staff levels to fulfil the contract. These wages will need paying during the term of the contract often resulting in the business having to fund the period before receipt of monies from the customer.
Overheads – without sufficient controls in place it is very easy to allow overhead expenses to escalate, which in turn puts pressure on cash flow.
So what measures can be put in place to mitigate the risk? As mentioned above the business should be working towards a measured business plan which budgets for growth within a manageable cash flow. Customer debts should be collected within strict credit terms and for larger contracts an agreement should be in place for customer deposits or stage payments. Stock levels should be controlled in order to reduce the length of time cash is tied up in stock in hand, and general expenses regularly reviewed to avoid wastage and ensure they are essential to the business.
Accurate and timely financial information is required which allows you to identify when action is required so you can act quickly and decisively, and if assistance is required seek professional advice at the earliest opportunity.
Most importantly always consider the effect on cash flow when dealing in transactions and remember that a sale is not a true sale until the cash is in the bank.
For further information or advice please contact Carl Page.