By David Logan - Sunday, June 28th, 2009

The issue

Business people know that their business cannot effectively operate without proper cash flow. The issue is to gain an understanding of the details of your businesses cash flow needs, anticipate problems and have solutions. In general if your cash flow has deteriorated and the bank is calling you to repay a demand loan or you cannot make payroll for your employees, you have reached a point in your business with limited options. If you plan properly, you can hopefully avoid this problem.

First: Gain understanding of your business cash flows

Gain an understanding of what cash inflows are generated by, and what cash outflows are required by,  your business on a monthly basis. Review prior monthly financial information (financial statements, bank statements) for historical data and trends and really understand your business’s ability to generate cash and consume cash.

• If you are a retailer, when do you pay for your inventory and how soon does that inventory result in cash inflow to the business?
• If you are a business which sells on payment terms, know what the average collection period is for a sale. Sales are not cash flow if you cannot collect the cash.
• How much do you purchase from suppliers, when do you make the purchases and what are the payment terms to your suppliers?
• Does your business have periodic payments such as insurance which could be paid over 12 months instead of a single payment?
• Know when your GST and income tax liabilities are due. Do not ignore the required remittances and instalments as the government will not let you borrow from them and there are consequences for personal liability, as well as interest and penalties costs, if your business stops making required payments.
• If your business has a cycle of slow sales periods each year, review how much cash you need to have to get to the next busy sales period. This means knowing what the cash consumption of your business is each month for rent/ mortgage payment, salaries, communication costs, vehicle payments and operating costs, and similar costs.
• Integrate your vacation into the cash flow. If you’re absent on vacation, the business may not be selling (if you are a consultant) or you are paying for someone to replace you while you are away.
• Integrate your personal cash needs from the business. Understand when you will need to take cash from the business for personal needs. Be realistic. If you cannot take cash from your business to live, the personal stress may affect your ability to operate the business.

Second: Use your understanding of your business cash flows to create a planning tool

Use the above information to create a detailed cash flow statement for a six- to 12-month period. The Entrepreneurship Centre can assist you in details of how to prepare this document. The cash flow statement is meant to give you information so you can anticipate cash flow challenges in your business. 

Why take time to create this cash flow statement?

• You need to understand your business before you can ask others to help. If you need an increased line of credit, it is better to anticipate that need than to ask for an increase at the last minute to allow the business to meet a payroll obligation. Lack of information indicates that the business is controlling you.
• It is difficult to make purchase decisions and hire staff if you cannot anticipate business cash flows.

You have to make estimates of future cash inflows from sales. While actual results will vary, you now have a cash flow statement tool to allow you to plan, adjust and react.

Third: Cash flow problems will happen – how to react

Virtually all businesses will have cash flow problems at some time in the life of the business. Slow sales consume cash and so can rapid growth. There is no ready solution for all problems, but review your alternatives. Communication with your employees, suppliers and the bank will be critical to get them on board and trust that you have identified the problem and are working on a realistic solution:

• Determine if the problem is a temporary (large cash outflow for unexpected repairs) or longer term (loss of a major customer, new competition driving down prices). If temporary, consider approaching suppliers or your landlord to defer payment for a month. If you have a mortgage, ask the bank to rearrange principal payments for a certain period. Consider temporary layoffs or job sharing to reduce labour costs. Review your business assets and sell redundant assets to create cash flow. Consider selling inventory at reduced prices to create cash flow.
• If longer term problems exist, review your ability to borrow against your home equity or refinancing existing debt. Consider selling required assets and leasing them back from the purchaser to create cash flow. If the business is at a growth stage where you cannot finance the growth and the bank will not provide further borrowings, consider a business partner who would inject cash into the business.

Category: Expert Advice.
Industry: Technology, Retail, Services
Functional Area: Finance
Tags: cash flow, employee expenses, inventory management, line of credit, managing costs, P&L, payables, payroll, profit and loss, profit margin, receivables, refinancing debt, revenue, tax instalments, tax liabilities, taxes, trend analysis