Fact: Profitable businesses can go bankrupt, and companies making losses can have substantial cash
Ironically cash flow is not necessarily improved by an increase in sales. As sales increase, a business needs more capital (equity and loans) and ties up more cash in inventory and receivables, and often fixed assets.
The rate at which a business can grow is largely determined by the amount of capital it has to support this growth. When a business grows too quickly it will burn cash and thus have a negative cash flow.
Cash flow can be improved by:
- Reducing costs and expenses (if costs are reduced you pay less and thus use less cash)
- Reducing assets (a source of cash and improves cash flow)
- Improving processes and efficiencies (reduces costs, assets, re-work, waste, scrap and delays, thereby improving cash flow)
- Increasing sales.
1. Reducing costs and expenses
Costs can be divided into fixed and variable costs.
- Fixed costs remain unchanged, irrespective of the level of production. Examples include depreciation (the cost of fixed assets), leases, rental, insurance, rates and taxes, and certain salaries.
- Variable costs change in proportion to the level of production. Examples include raw materials, labour and sales commission.
Fixed costs are often linked to the level of fixed assets. Although the level of fixed costs and assets is often a function of the industry, companies can still choose between more capital equipment (fixed cost and asset) or more labour (variable cost). This choice should be based on which option is more productive and has the lowest cost.
It is difficult to reduce fixed costs and assets in the short term. However, since companies with high levels of fixed costs and assets tend to be more risky than those with lower levels, the objective is to keep fixed costs as low as possible.
Purchases of inventory or raw materials
Purchases are the biggest cost for most businesses. Retailers and wholesalers purchase inventory, while manufacturers purchase raw materials.
To reduce the cost of purchases:
- Develop relationships with your key suppliers and discuss your specific needs with them
- To prevent outages and to test prices, ensure that you have more than one supplier for most items, especially your key and expensive items
- Regularly test prices to ensure you are getting the best possible price
- If possible, take advantage of discounts on large purchases and early payment.
Related: Drive Up Value and Reduce Costs
Labour is another substantial cost for companies, especially manufacturing companies.
The objective is to increase productivity by:
- Improving business processes
- Establishing performance and productivity standards
- Comparing actual performance with
the established standards
- Using bills of materials and job cards
- Improving quality in order to reduce
re-work and scrap
- Ensuring staff are properly trained and qualified for the position.
The net result is a shorter, more efficient production cycle, which reduces costs, assets, re-work, waste, scrap and delays, thereby improving cash flow.
2. Reducing assets
Assets consist of fixed assets and working capital (current assets less current liabilities). Fixed assets include property, plant, equipment, motor vehicles. Current assets include stock or inventory, and debtors or accounts receivable, while current liabilities include creditors or accounts payable.
Fixed assets, like fixed costs, are difficult to reduce in the short-term and are typically a function of the industry the business operates in.
With a view to reducing your fixed assets:
- Assess your level of vertical and horizontal integration in the value chain
- Determine where the value is in the value chain
- What assets in the value chain should you own and how do you control the other assets
- Are there opportunities for outsourcing sales and leasebacks
- Consider leasing instead of buying.
Working capital management
The management of working capital is critical to a business. The objective of working capital management is to reduce the cash cycle.
Reducing the cash cycle is achieved by:
- Reducing inventory or stock: Reducing the time (days) between buying and selling inventory
- Reducing receivables or debtors: Reducing the time (days) between selling inventory and receiving payment for the sale from your customer
- Extending payables or creditors: Extending the time (days) between purchasing and paying the supplier for the purchased inventory.
- In a best case scenario, you will be able to sell and be paid for the goods you sold, before you have to pay your supplier.
Here we want to reduce the quantity and costs of inventory.
Inventory costs consist of:
- Carrying or storage costs: Rent, insurance, material handling, obsolescence
- Ordering and shortage costs: Time spent ordering, paying and receiving the goods, transport, and loss of goodwill, sales revenue and production time.
There is an inverse relationship between these costs – carrying costs increase with higher inventory levels, while ordering or shortage costs decline and vice versa. The goal of inventory management is to minimise the sum of these two costs.
- Sell old or obsolete stock: Selling at cost would be great, but the objective is to get rid of the stock, even if that means selling below cost price, and to generate cash while reducing your holding costs
- Reduce the production cycle: In manufacturing companies, reducing the production cycle will reduce inventory levels since the time between purchasing the raw materials and selling the finished product will be shortened.
The ABC inventory management system
Divide all inventory items into three or more groups in terms of:
- Inventory value (usage rate x individual value)
- Order lead time
- Consequences of shortages.
Here the logic is that a small quantity of inventory might represent a large portion of inventory value.
- Group A: Consists of all high value inventories. Stock is kept to a minimum and all items are strictly monitored and tightly controlled. Precise ordering is important.
- Group B: Items are of medium value and require a medium level of monitoring and control.
- Group C: Inventory comprises basic, inexpensive items. These items are ordered in large quantities to ensure continuity of supply, while monitoring and control is not that important.
Controlling receivables (money owed by our customers) is the key to cash flow management in any business. First establish a policy which, amongst other things, covers:
- Who you grant credit to
- How you assess the granting of credit
- What your collection policy is.
- Request down and milestone payments
- Invoice daily instead of weekly or monthly
- Offer cash discounts to encourage early settlement
- Closely monitor accounts, taking swift action on overdue accounts.
Extend payables (money owed to suppliers) by:
- Paying in terms of your payment terms:
If terms are 30 days, don’t pay on 15 days
- Delaying payment without losing supplier goodwill or trade discounts
- Negotiating better terms with your suppliers
- Communicating and establishing relationships with your suppliers.
When choosing a supplier, negotiate and base your decision on both the purchase price and the payment terms.
Cash discounts are usually attractive and, if possible, it is worth taking advantage of them.
3. Improving processes and efficiencies
Improving processes and efficiencies reduces costs, assets, re-work, waste, scrap and delays, thereby improving cash flow.
As mentioned earlier in the article, an increase in sales does not necessarily improve cash flow. As sales increase a business needs more capital and ties up more cash, primarily in inventory and receivables, but often also fixed assets.
However, without sales you don’t have a business, and you won’t have a profitable business, since you will not have any revenues to cover your fixed and variable costs.
While each of these elements has been discussed individually, they are all intertwined and woven together, so reducing or increasing one element will often impact on the other elements and have a ripple effect throughout the company.
Five simple steps to get started now:
- Prepare a forecast of your expected sales and expenses, taking into account cyclical trends. Remember that sales are a combination of selling price and the number of units sold.
- From the forecast, project your actual cash flow requirements and ensure that you have sufficient capital (cash) from shareholders and loans to meet your requirements.
- Target sustainable growth levels.
- Check your pricing and margins — how do your prices compare with your competitors and have your prices kept pace with your increasing costs?
- Implement regular price adjustments — especially if you are an importer and your input costs vary with the exchange rate.
Ensure that you know:
- The cost of manufacturing or purchasing a product
- The gross profit of each product
- The number of each product being sold
- How much effort (time) is required to sell a product
- Your top customers by sales and profits.
Financial Literacy Key To Business Success – Especially In A Tough Economy
What can South African SMMEs do to position themselves for success in tough economic times? Arming their people with basic financial literacy is a good place to start argues UCT Graduate School of Business Associate Professor Mark Graham.
In times of economic hardship, good financial and management skills in a business can make all the difference. According to a recent article in Business Day, international investors are sniffing about South African SMMEs that have proven themselves to be well-run during this time of subdued economic growth – and are also attractively undervalued.
Strong balance sheets and stable management in an environment of slow growth economy with low liquidity adds up to some bargain long-term investment opportunities for international consortiums it seems. Among those who have been involved in investment or buyout offers in the past few months are Clover and Interwaste.
It seems self-evident to suggest that well-run businesses attract investment and success. But what actually makes a business – of any size – well-run in the first place?
There is obviously no short answer to this; good leadership, a clear strategy and a strong and motivated workforce all play their part, but one factor that is often overlooked is financial acumen – throughout the organisation. While the accountants and members in the finance team are expected to understand the numbers, this is not always a core competency required in other departments. Yet, having a good working knowledge of finance at every decision-making level, from new managers to members of the board, can be key.
Even if people don’t need to know a lot about finance in their day-to-day job, the more conversant they are on the subject, the better off they – and the business – will be, according to Richard Ruback, a professor at Harvard Business School and the co-author of the HBR Guide to Buying a Small Business. “If you can speak the language of money, you will be more successful,” he says simply.
Financial savvy will give the marketing manager the ability to demonstrate not only that something is a good idea/product or service, but that it makes financial sense too, for example. And it will make sure that the people in the HR team understand more clearly why reducing staff churn is a good idea not only for company culture but for the bottom line as well.
A knowledge of some basic financial decision-making tools (the all-important balance-sheet, for example) and an appreciation of the difference between profitability and cash flow will ensure that non-financial managers are more likely to effectively participate in business strategy and decision-making. Someone who understands the financial statements of a business understands the business in a way that is not otherwise possible. It’s like looking beneath the hood of a car and understanding how it all fits together and why the car can move forward – or not.
Such people can more confidently identify potential problems and inefficiencies before they impact the overall financial performance, because those warnings are almost invariably reflected in the financials first – and often at departmental level. Critically, they can also help identify financial irregularities, enabling them to call out and stop fraud and corruption in its tracks.
Equipping its people with financial skills is therefore a good strategy for a business looking to position itself for growth and investment. And it makes sense for individuals too – Joe Knight, a partner and senior consultant at the Business Literacy Institute in the US and the co-author of Financial Intelligence, says that an absence of financial savvy is “career-limiting.”
Let’s not ignore the fact that there are challenges however. Finance matters tend to scare a great many people. Traditionally, these areas of knowledge carry the stigma of being impenetrable, and financial literacy is not ideally developed at early levels. According to a study by the Financial Services Board, South Africa currently has a financial literacy rate of just 51%.
This means that roughly one out of every two people is likely to prefer to abdicate from financial decision-making – leaving it to the “numbers” people. But with some intervention and training it is possible to empower individuals to decode these mysteries and get to grips with the language of finance.
All things being equal, it’s not pure luck that allows some businesses to operate well and thrive while others fail. Well-run businesses are generally run by well-informed people. In short, decision-makers who don’t understand basic financial concepts and the language of finance simply don’t know what is going on.
While the SA government is currently talking up the need for foreign direct investment to rescue the country from the economic doldrums, there is much that ordinary businesses can do to position themselves for success. And ensuring that their people are adequately equipped to understand the nuances of business through the language of finance is perhaps a good place to start.
Trade Agreement Tips That Will Save You Costs
If you are looking to benefit from trade agreements, you need to keep the following advice in mind.
Trade benefits all parties involved. When a country has scarcity of certain resources or lack the capacity to satisfy their own needs, they have the opportunity to trade the resources which they produce in surplus, for the products they need or want.
When goods are transferred from one country to another, it stimulates the economy as products and money is switched between hands. Over the years, the competitive nature of moving goods from one country to the other, negotiating prices and opening new markets has caused certain agreements to immerge to promote trade between the member countries.
A trade agreement is an arrangement between two or more nations in order for goods to move more easily between borders with mutually beneficial tariffs imposed on imports. These agreements ensure that duty tax is removed or reduced on condition that the importer and exporter provide the correct documents. This is all the more reason for traders to familiarise themselves with the current trade agreements in place.
Tip1# Know Whether You Export To Or Import From A Country With A Trade Agreement
There are a few trade agreements that you need to be aware of which will significantly cut duty tax. The Southern Africa Development Community (SADC) Free Trade Agreement (FTA) is one of them. The fifteen SADC member states included in the agreement enjoy an impressive 85% free trade on goods.
Another trade agreement commonly used by South Africans is the South African Customs Union (SACU) which allows duty tax free movements of goods. This means zero duty tax is payable on trade between these countries. Trade agreements with European countries include the SADC-EU Economic Partnership Agreement (EPA) and the SACU European Free Trade Association (EFTA). We have prepared a list of all the trade agreements as well as the countries involved here.
Tip 2# Know Which Certificate Of Origin Is Necessary For The Specific Trade Agreement
Only traders who can prove that goods were produced or processed in a member country may benefit from these agreements. This is why importers and exporters need to submit paperwork attesting that the goods were made in the country listed as the beneficiary of the trade agreement. The proof provided is called a ’Certificate of Origin’.
A certificate of origin often abbreviated to C/O or CoO is a printed form or electronic document completed by the exporter and certified by a recognised issuing body, validating that the goods in a particular export shipment have been produced, manufactured or processed in a particular country.
The exporter has to submit proof that either a) the products were wholly obtained from that country; this means all components and manufacturing originated in that country, or b) that it is sufficiently processed in the country of origin.
In other words, although some components might have been imported, the product was sufficiently transformed, or value was added in such a way that the final item can be deemed as new or original. Furthermore, if a company was registered in one country and the manufacturing plant in another, the certificate of origin would be issued from the manufacturing plant’s country. There are various certificates of origins used for different countries. Read here for more details about the different documents required to ensure you benefit from lower duty tax.
#Tip 3: Ensure The Certificate Of Origin Is Completed In The Right Manner
These documents must be completed correctly. Most of the information provided has to come from the exporter. If the wrong information has been reported, it can influence the relationship between the importer and exporter negatively.
Common mistakes when filling out a Certificate of Origin may include:
- Identifying the wrong country of origin
- Using the wrong H.S. code
- Providing an incorrect or incomplete and rather ambiguous description of the goods
- Not including a description on how the cargo is packed or reporting a total weight that does not include packaging
- Exporting goods made from imported material and not sufficiently processed to be deemed as originating from the exporting country.
A lot of information can be misrepresented on the certificate of origin. For this reason, we recommend making use of companies specialising in trade administration to ease the stress and to ensure that all the t’s are crossed and i’s are dotted.
Backing You With Smarter Tools
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The new “Backing You” campaign extends this commitment to support small business owners through the challenges of business ownership – with a little help from Danny DeVito.
“The importance of small business is personal to me. At a young age, I watched both my parents and my sister build their own business from the ground up and struggle to balance family obligations with growing their businesses,” says DeVito.
“When Intuit QuickBooks approached me for this campaign, I felt this was a way that I could give back to this very important industry, show them how to make their lives easier and make them laugh along the way too.”
QuickBooks gives you a set of business tools that’ll do all the hard work for you, making sure you get the time to do what really matters to you. “Because collecting receipts is so 80s, and who has time to chase payments?” says Danny.
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