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.
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.
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.
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.
Please speak to one of our consultants or call 0860 111 123 or visit your nearest branch.
Absa Business Banking
Do better business. Prosper.
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.
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.
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.
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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.
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.
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.
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.
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.
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.
Digitisation is transforming business functions across the board. Technologies, like cloud software can take care of laborious administrative work.
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.
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.
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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