When it comes to managing finances, a businessman’s greatest concern is the cash cycle.
A tight cash flow can be a real problem. Surprisingly, many business owners fail to anticipate and prevent a cash crunch. Here are some pointers to effectively manage your cash flow:
- Understand your cash cycle
Every business has a cash cycle. Look at this like blood flowing in your business. Since it is a cycle, what goes out must come back. It starts from the point when you release cash to the time you get it back. The shorter that period is, the better. In trading or retail, you release money to pay for goods or raw materials. They are processed, packed, stored in warehouses before they are distributed to your buyers. Or you may be selling services instead of goods, in which case, you are paying salaries to your direct personnel, who may be cleaners, photographers, editors or installers or you may be paying for subcontracted labor. The cash you release to pay for those must come back to you in a bigger amount to cover your overhead and profit.
- Watch your receivables
If you are giving your customers credit, say 30 days or more, that means your cash is tied up in receivable before they become cash. A delay in collection can affect your cash flow. If cash will be short because of this, make sure you don’t fall into borrowing at ridiculous high interest rates to cover your cash flow gaps.
- Monitor your inventory level
If you are dealing in goods, whether wholesale or retail, regularly monitor your inventory level. An increase in inventory means tied up cash. A decrease means inventory that has been converted into cash. A client of mine dealing with rapidly changing demands of his customers did not notice his overstocking on items that are rapidly becoming outmoded. Since new models were moving quickly, his focus veered away from the increasing inventory of old items. This resulted to tight cash flows. The problem eased only after he disposed of the old stock in a garage sale. Suppliers may be offering discounts if you buy in bulk. Before you decide to avail of their promos, evaluate the effect of higher than usual inventory on your cash.
- Gross Margin
This is your profit expressed as a percentage of your sales. They vary from industry to industry. They are also affected by your efficiency. Your gross profit must cover your overhead and after that, produce an income. If your overhead is too big to be covered, you see red. If this happens, your margins may be too thin, or your sales are too low, or your overhead is too high. All 3 factors if managed well, will result to income.
Think like a salaried person and know your fixed monthly expense. All your recurring items, such as your salary and salaries paid to your employees, utilities, office rental, supplies, etc., fill up this item, which is an expense that is almost fixed and is not dependent on how much you sell. Your effective management of overhead, which means carefully evaluating decisions that result to additional fixed expenses (e.g. increasing rent, adding personnel, advertising, etc.) may spell the difference between income and loss. Wise managers do not allow significant increase in overhead unless they foresee a resulting increase of sales and income.
- Capital Expenditures
I have seen many miscalculation in this item that resulted in major disruption in the business. A businessman decided to put up a showroom for his products. This involved renting a property, then putting up a building. When the building was finished, money that was supposed to pay for raw materials was depleted. The owner resorted to borrowing to augment his working capital. But the interest cost is more than 3% per month. These series of decisions set into motion a serious disruption in the cash cycle which brought operation to a slowdown. With deliveries delayed, customers started cancelling orders and demanding reimbursement of deposits paid. More borrowings became the unavoidable solution which further aggravated the already bad financial condition. Careful evaluation of capital expenditures and how it is to be funded can prevent serious cash flow problems.
- Unbridled sales expansion
Expansion in sales does not always result to positive cash flow. Increase sales volume may mean more inventory and receivable which stretches your cash. Before you grab the huge order, try figuring out how you will fund the increase in your inventory and receivables.
Prudent management of the cash cycle results to more time being spent in studying how customers can be served better. That is where the major focus should be.
Proverbs 14:15 – The simple believes everything, but the prudent gives thought to his steps.
Bless the work of our hands, O’ Lord!