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Cash is King: Managing Cash Flow for Business Survival and Growth

In the end, business survival and growth almost always come back to the same thing: cash!

Greg Fisher

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Part 1

Description of Cash Cycle Analysis

The cash cycle represents the use of cash in the day-to-day operations of the business. A cash cycle analysis is a process of looking at how cash might be unnecessarily locked up in the workings of the business. Within any business, there are three areas where cash may be getting unnecessarily ‘trapped’:

1. Accounts receivable

What customers owe for what you’ve sold on credit. This represents money that ‘belongs’ to your business but is currently inaccessible for operating the business.

2. Inventory

Materials, work-in-process, and finished goods on hand for manufacturing and distribution companies or unbilled services for work already performed but not yet invoiced for service firms.

3. Accounts payable

What you owe suppliers for what you’ve bought on credit. This is an area where, if you fully utilise the credit given to you by suppliers, you can release extra cash into your business.

In doing a cash cycle analysis one carefully analyses how much cash is locked up in each of these elements of the business and then works to unlock this cash in a safe and responsible way. How do you perform a cash cycle analysis to unlock cash within your business?

Step 1

Calculate the cash days for each element of the cash cycle

The first step is to understand how many days’ worth of cash are locked up in each element of the cash cycle. The cash locked up in accounts receivable is calculated as the accounts receivable balance divided by the average sales per day. The cash locked up in inventory is calculated as the inventory balance, divided by the average daily cost of sales; and the cash days in accounts payable is the accounts payable balance divided by the average daily cost of sales (see the equations below for the calculation of these amounts). The total days in the cash cycle can then be calculated as accounts receivable days, plus the inventory days less the accounts payable days.

Step 2

Assess whether the number of days’ cash in each element of the cash cycle is reasonable

All businesses need to have some cash tied up in the cash cycle but the key to effective financial management is to reduce the overall days tied up in the cash cycle to a competitive level. Therefore to have more cash to grow the business you need to try to reduce the number of days in accounts receivable and inventory and to increase the number of days in accounts payable within a range that is reasonable and sensible.

Having calculated the number of days in each element of the cash cycle in step 1, the next step is to assess your business days in each element of the cash cycle in relation to:

  • The number of days in prior periods to see if cash management is improving or declining
  • The number of days provided for in firm policies (the policies of your firm for accounts receivable and inventory and the policies of your suppliers for accounts payable)
  • The number of days of other firms in the industry  (see alongside)

By comparing the days in each element of the cash cycle over time, one can see whether you have been more or less effective at managing your cash over time. By comparing days to firm policies you can assess if firm policies are actually being implemented and by assessing the days’ cash in comparison to others in the industry you can assess whether you are competitive compared to other firms.

Step 3

Set targets for managing each element of the cash cycle

Most people discover that there is room for improvement with respect to the amount of cash tied up in accounts receivable, accounts payable or inventory. The next step is to set targets to improve these balances. The targets for these amounts should be reasonable within the industry in which the firm operates. You should set targets that are ambitious but not so unreasonable that you are unable to operate effectively. For example it may be an industry norm to expect customers to pay invoices on 30 days. It is then unreasonable to set a target of 15 days for accounts receivable. You may need to keep a certain amount of inventory on hand to maintain customer service levels; it is then destructive to set targets that reduce inventory levels to levels that are dangerously low. It is also unwise to set a target to pay accounts payable on 50 days if your supplier’s policy is 30 days; you will just develop poor relations with your supplier.

Step 4

Start managing each element of the cash cycle

Having set targets for improvement, it is time to go to work on managing these balances to achieve the targets that you have set for your business.

To reduce accounts receivable you could:

  • Look to get invoices out more efficiently (eg by email). Incentivise the people in accounts to send out invoices as quickly as possible.
  • Adjust the credit policy to reduce the number of days’ credit allowed to customers (but only do this if it will not have a significant negative effect on sales).
  • Actively follow-up with customers to collect receivables within the credit terms that you have given them.
  • Incentivise customers to pay early (eg by offering discounts or rewards).

To manage the inventory levels downward you could:

  • Identify what inventory you need regularly and what you need less regularly and manage it accordingly, with lower inventory balances for stock that you seldom need.
  • Keep smaller amounts of stock on hand and set up relationships with suppliers where they agree to provide goods more regularly in smaller batches.
  • Identify slow moving and obsolete stock and provide incentives to move it off the floor.

To release cash within the accounts receivable balance, you could:

  • Ensure that you are using the credit terms that customers provide.
  • Negotiate longer credit terms with customers.

If the targets that you set are reasonable and you implement these tactics in a reasonable and responsible way, over time you should be able to reduce the amount of cash tied up in the cash cycle to achieve your goals and have more cash to build the business.

Step 5

Review progress

The cash cycle needs to be reviewed and managed on an ongoing basis. It is amazing how easy it is for the accounts receivable and inventory balance to creep up if unchecked, thereby sucking cash out of the business. The cash cycle numbers — accounts receivable days, inventory days and accounts payable days — should become part of the monthly management dashboard for any business. Managers who observe that these numbers are moving in the wrong direction should immediately investigate and take action to rectify the situation. In this way you can ensure that the business has as much cash as possible to continually fuel growth. »Many times managers think that a cash injection into a business must come from outside the organisation — they desperately apply for bank loans or try to contact a long lost rich uncle to invest in the business. The reality is that you can often engineer extra cash from inside your business if you just manage your finances more effectively. What can you do to ensure that you have adequate cash to keep your business alive? In this article we will highlight a specific process for managing and unlocking cash in your business.

Accessing financial data on other firms in your industry

The easiest place to find financial information about other firms in your industry is to look at the financial statements of firms that are listed on the JSE or AltX exchange.

These firms are required to publish their annual financial statements so their financial information can be accessed via one of the following sources:

  • The company website — usually under the investor relations section
  • The Moneyweb website — go to the website (www.moneyweb.co.za); in the top right corner go to “CLICK-A-COMPANY”; click on the names of the companies that you are interested in and then look for SENS announcements further down the page that contain financial results for the company. From these announcements you can get information required to calculate the number of days in accounts recievable, inventory and/or accounts payable.

Part 2

Case Study

Presto Print

Presto Print is a local printing business doing bulk printing jobs for small and medium size businesses. Samantha Graham, the manager of Presto Print, wants to expand the business but to do so she needs to buy two new printing machines valued at R110 000. She was convinced that she would need to get a bank loan to buy the additional machines but her corporate banker was not getting back to her with an answer on her request for finance.

Getting frustrated she wondered whether there was another option. An examination of her recent set of financial statements reveals that there may be.

Step 2

Assess whether the number of days’ cash in each element of the cash cycle is reasonable

Based on the table of comparisons, it is evident that Samantha Graham needs to implement better accounts receivable management practices at Presto Print. The number of days’ cash in accounts receivable is creeping up over time and it is much higher than the firm policy and the industry average. It also appears that there is room for improvement in her inventory management practices.

She has too many days’ worth of cash tied up in inventory compared to the industry average and she has never established an inventory management policy specifying how much inventory she intends to keep on hand. There appears to be less opportunity to release cash through the accounts payable balance. It would be irresponsible to extend it much higher than its current level as her suppliers credit policy is for outstanding invoices to be paid on 30 days.

Step 3

Set targets for managing each element of the cash cycle

The next step is to set targets for how many days’ cash Presto Print should aim to have tied up in each element of the cash cycle. Based on the assessment of the industry averages and the firm policies and after consultation with the other employees in her business, Samantha Graham decided to set the following targets:

  • Accounts receivable days:  36 days
  • Inventory days: 30 days
  • Accounts payable days: 35 days

To achieve these targets she would need to reduce accounts receivable by 11,93 days, which would result in (R2 101 085 /365 days) x 11,93 days = R68 673 extra cash. If she reduced inventory down to 30 days she would release another (R845 095/365 days) x 38,92 days = R90 113 worth of cash into the business. Therefore, through careful management of the accounts receivable and inventory balance there is the potential to release more than R150 000 worth of cash into the business at current business levels.

Step 4

Go to work at managing each element of the cash cycle

Having established reasonable targets for each element of the cash cycle, the next step is to aggressively manage these elements of the business to achieve the targets.

To do this, Samantha Graham first shared the targets with all her staff and explained why and how the management of these elements of the business would have a significant positive impact on the business. Furthermore, she promised that if they achieved the targets and maintained them for six months she would take them and their partners out for a dinner at a fancy restaurant and grant each of them two extra days of paid leave in the following year.

Thereafter, she worked with her accountant to put more processes in place to get invoices out quicker and to follow up on payments five days before they are due, on the day they are due and every two days after they are overdue. She also reviewed her debtors book over the last two years and identified the clients that were most guilty of paying very late. She called each one up and had a friendly but firm conversation with them saying that she was thrilled to have their business but then reminding them of the policies and asking them in a nice way to please try to comply.

Furthermore, she reviewed the inventory balances for the past two years and discovered that they were keeping large amounts of paper on hand that was very seldom requested by clients. She identified all the paper that fell into this category and called her supplier asking if they would be willing to take some of it back at a discount as payment for some of Presto Print’s recent purchases. They agreed! She then categorised all the paper and ink that they stored on hand according to how regularly it was used. She set targets for the amount of each category of inventory

they would keep on hand. She then called Presto Print’s suppliers to confirm how long it would take them to deliver paper and ink from the time of order. Using this information she set reorder levels for each category of inventory. She made the reorder levels clear to all her staff and instructed them to inform her when they reached the reorder levels. After seven months of implementing these simple but effective tactics, the accounts receivable and inventory levels were nearing their targets and Samantha had much more free cash flow in the business to fund growth and capital acquisitions.

Step 5

Review progress

After a few months, Samantha asked her accountant to create a simple weekly report that would give her the weekly sales, the number and amount of invoices sent out that week, the accounts receivable balance, the inventory balances by category and the accounts payable balance. This information gave her much richer insight into her business and allowed her to make highly informed management decisions. She put the targets for accounts receivable days, inventory days and accounts payable days up on a large whiteboard in the office. Each month she filled in the actual balance next to the target so that all employees could see how close they were to achieving the target.

Greg Fisher, PhD, is an Assistant Professor in the Management & Entrepreneurship Department at the Kelley School of Business, Indiana University. He teaches courses on Strategy, Entrepreneurship, and Turnaround Management. He has a PhD in Strategy and Entrepreneurship from the Foster School of Business at the University of Washington in Seattle and an MBA from the Gordon Institute of Business Science (GIBS). He is also a visiting lecturer at GIBS.

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Cash Flow

The Simple Way To Pay Wages When Your Staff Don’t Have Bank Accounts

If you have employed casual workers over the busy season, you can pay wages even if they do not have bank accounts.

Absa

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At Absa Business Banking, the things that are important to you are just as important to us. We understand your business needs, which is why we have developed tailored solutions to help you where it counts. Take CashSend Plus, for example. It is a payment solution that enables you to pay workers even if they do not have bank accounts.

Related: Hiring Your First Employee? 5 Things You Need To Know

It is safe and secure

Your employee will receive a six-digit access code and a ten-digit reference number, so that they can verify the transaction. The money is instantly available at an Absa ATM.

You can even pay yourself

We have all lost bank cards or wallets at some point in our lives. What an inconvenience. Well, it is good to know then that you can access cash by sending it to yourself. Now, that is what we call better. 

Related: How Salary Transparency Empowers Employees – And When Not To Use It

Interested?

Please speak to one of our consultants or call 0860 111 123 or visit your nearest branch.

Absa Business Banking 

Do better business. Prosper.

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Cash Flow

Entrepreneurial Balancing Acts with Debt

Young South African entrepreneurs face many challenges when it comes to debt-related financing. Small and medium enterprise (SME) owners typically require extensive debt financing from bank and non-bank lenders.

Harald Merckel

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Young South African entrepreneurs face many challenges when it comes to debt-related financing. Small and medium enterprise (SME) owners typically require extensive debt financing from bank and non-bank lenders. Unfortunately, many South African entrepreneurs are limited in their ability to access capital markets. Among others, the major challenges facing entrepreneurs include lack of credit history, no collateral, shaky credentials, and unformulated business plans.

Regardless, SA entrepreneurs are forging ahead and using multiple resources at their disposal such as payday loan providers, non-bank lenders, family and friends, crowdfunding and other economic empowerment initiatives to raise the necessary seed capital for investment purposes. Given the staggering unemployment rate in the country (+25%), the only way out for many people appears to be entrepreneurship. The 2008 global financial crisis threw the economy for a loop, and now the hopes and dreams of many South Africans hang in the balance.

Related: Every Tough Choice Has Management Debt – Are You Accounting For Yours?

ISM Study Sheds Light on SA Entrepreneurial Pros and Cons

An intensive study conducted by the University of Cape Town’s Unilever Institute of Strategic Marketing (ISM) found that the country is experiencing ‘a crisis of aspiration’. Simply put, many South Africans are struggling to attain their career objectives in an economy that has been ravaged by corruption, mismanagement, and scandal. Despite tough economic times, South African entrepreneurs are determined to try their luck. Pressing challenges in the form of rising unemployment, and an economy mired in failure are challenging entrepreneurs to be more inventive than ever before. The most volatile component of the economic spectrum in South Africa is the middle class.

Many South African families have lived the high life, or ascended the rungs and then been knocked down a peg. This instability is creating added volatility in a country where high crime, mismanagement and political rancour pepper the scene. For many entrepreneurs, any access to credit is a godsend. Banks and non-bank providers offering personal loans, business loans, or credit card funds invariably expose themselves to debt default. For entrepreneurs, it’s important to know where to draw the line. Access to lines of credit in a crippled economy is significantly more valuable than the equivalent access in a developed economy.

How to Know when you are Overstretched as an Entrepreneur

Debt is considered a prerequisite for investment purposes. Most South Africans simply don’t have the necessary capital to start up a high-tech venture, fund a new business, or conduct marketing and advertising activity. As such, lines of credit are increasingly being used to propel business activity among SMEs – both in the formal and the informal sector. However, once debt reaches untenable levels, the tough questions need to be asked. For example, if multiple loans and multiple payments are required monthly, revenue streams need to be evaluated against expenses to gauge whether this is a feasible status quo.

Related: How To Handle Your Post-Holiday Debt

Many entrepreneurs find it difficult to manage multiple loans simultaneously, although it is necessary to acquire the capital from multiple sources. One of the ways to deal with these types of exigencies is a single loan from a low-cost lender in the form of debt consolidation loans. Simply put, these loans are provided by bank or non-bank lenders at lower interest rates than the prevailing interest rate on other lines of credit. By taking out a debt consolidation loan, the entrepreneur has more disposable income over time by not paying the higher interest on credit card debt.

Escape Debt Before Debt Consumes You

There are several other ways to know when your personal financial situation has reached critical mass. For starters, the nature of your business may require you to continue dipping into lines of credit to maintain business operations. If you don’t have the requisite discipline to stop indebting yourself, you may not be able to get out of debt. Debt consolidation is only effective insofar as you have the necessary discipline to put an end to debt financing of all business-related activity.

Credit should be used sparingly, and profits should be generated to allow your business to prosper. In a tight economic climate, costs are the bugbear that need to be attacked. Lavish trappings are unnecessary for business functionality – modest budgets, and high-quality goods and services are far more effective than window dressing at a premium.

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Cash Flow

How South Africa’s Small Businesses Plan To Invest Their Money In 2018

Here are their five areas they should focus their attention on in the next year and beyond.

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Despite economic uncertainty, South Africa’s small businesses are positive about the future. In fact, our State of South African Small Business report reveals that 40% of small businesses are expecting to grow. However, to achieve growth without overextending their limited resources, small businesses need to invest wisely.

Here are their five areas they should focus their attention on in the next year and beyond.

Marketing

When times are tight, companies typically reduce their marketing spend. This isn’t the case for 36% of South Africa’s small businesses. These respondents recognise marketing as a critical investment area.

They’d rather make a concerted effort to grow their customer base, than sit still and do nothing as consumer demand declines.

Related: What To Consider When Investing Your (Hard-Earned) Money

Technology

Without access to the latest technology, business growth can quickly stagnate. This is why 23% of South Africa’s small businesses plan to invest in up to date equipment, whether that be new machinery, mobile devices or computers.

The right investment in this area can give a business a real competitive advantage.

It can help boost profits and improve operational efficiency – both of which can help a small business withstand difficult economic conditions with greater success.

Product development

Consumers are spoiled for choice. Their needs are constantly changing and companies can’t afford to become complacent. To keep up with market demands, 22% of small businesses plan to invest in product development. Barring a few timeless classics, most products need a regular review and tweak to stay relevant and popular.

Technology

technology-south-africa

Digitisation is transforming business functions across the board. Technologies, like cloud software can take care of laborious administrative work.

Related: How To Make Money Investing, According To Ashton Kutcher

This liberates employees from time-consuming tasks, enabling them to focus on more strategic work like customer retention and acquisition.

Technology has the power to improve productivity and efficiency. Which is why 18% of small businesses are going to focus their investment plans on this area of their businesses.

Customer service

The customer should always be the priority. It doesn’t matter how good a product is, if there are no customers, then there’s no business. As competition increases, the user experience becomes more and more important to win over customers.

Business growth depends on happy customers and to achieve that, 18% of small businesses plan to invest in delivering better service.

All five of the above business areas are worthy investment focuses. The question is, how does a small business work out what to invest where? The only way it can invest effectively is with a full view of its company finances. A small business needs to be able to see which functions have provided the best return on investment to date.

Related: 12 Millionaire Habits To Start Making Serious Money Soon And Build Wealth In A Hurry

It also needs to consider how much investment capital it has to spend. What’s more, before it makes an investment in say, marketing or product development, it must know exactly how and where the money needs to go.

The right software can help a small business access the real-time insights it needs to make better, faster financial decisions. To combat increased competition and market uncertainty, South Africa’s small business owners need access to up-to-the minute information from any device no matter where they are. An informed investment has the greatest chance of success.

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