One of the biggest challenges for businesses – big and small – is cash flow. It doesn’t matter how profitable your business is, if you don’t have enough cash to pay staff, suppliers or rent, things can become really bad, really fast.
Here are some of the common mistakes we see businesses make when it comes to cash management.
Not having a cash flow forecast
Many businesses will focus too much on their profit and loss statement, not realising it only tells part of the story. If you want to understand whether you’re likely to experience any cash flow pressures down the track you need to forecast and track how much cash is coming in and out. The best way to do this is to create a cash flow forecast.
A cash flow forecast will predict when cash is coming in and out, arming you with the information you need to determine the best times to spend or save. This data will ensure you always have enough cash to operate and cover your obligations. It will also make sure you’re not eating away at your cash reserve too quickly.
Not addressing lumpy cash flow
If your business has lumpy cash flow where the cash entering and exiting your business each month varies significantly, it may not seem like an issue, but it can quickly cause problems. Lumpy cash flow is harder to predict and track, and overall will mean you have some easy months and some hard months when it comes to cash flow.
By taking steps to reduce lumpy cash flow by adding a recurring revenue stream, shifting expense payments to monthly rather than yearly, or moving clients onto a retainer, it can make it much easier to handle cash flow each month.
Not holding a cash reserve
If you don’t have a cash reserve, then you will inevitably find that you will have to go into debt to cover cash flow pressures. Sometimes this may be necessary at certain times in a high cost business, but the goal should be to accrue a cash reserve to cover you most of the time.
Not improving accounts receivable processes
Many businesses struggle with getting paid on time. Instead of chalking it up as being one of the realities of business, you should do what you can to improve your accounts receivable processes so you don’t get stuck.
Make sure you invoice or bill promptly and have a process for following up overdue payments. Charging interest on overdue invoices or bills can deter customers from not paying on time. Alternatively you can incentivise early payments by offering discounts.
You may also want to look at how you can shorten the time to payment. Invoice at the beginning of the month, or charge for milestone payments and deposits so you’re not waiting for one lump sum payment.
Not streamlining accounts payable processes
If you’re paying your suppliers ahead of time, this could be creating unnecessary cash flow pressures. What you want to do is incorporate as much flexibility as possible into the process. Make sure payment terms are suitable for you and pay as close to the due date as possible.
Not covering liabilities
The liabilities in your business need to be factored in so you always have enough cash to meet your financial obligations. That includes wages, superannuation, leave entitlements, money owed to suppliers and tax.
It also includes having enough cash available to pay out employees’ entitlements when they exit the business such as annual leave or long service leave. If your employees are accruing too much leave which would create a big cash burden should they leave, it may be time to enforce some mandatory leave.
Thorough tax planning will also ensure you know how much tax you will owe and ensure you’re holding onto the cash you’ll need to cover it.
One way to ensure you have enough cash put aside for these obligations is to use a separate bank account. This will help you maintain a cash reserve to cover these costs so you’re not caught out when these costs come up.
For any discretionary spending, it’s also a good idea to regularly review your spending and cut costs where appropriate.
Not understanding runway
If a startup doesn’t understand from the outset how long they have until they run out of money, they can end up chasing funds when they’re desperate. This can lead to poor decisions around funding, because the startup has run out of options. Instead, calculating the runway early on and subsequently planning for cash needs such as when to raise capital or when to access a debt facility, will put a startup in a much stronger position.
Drawing on cash reserves which could be deployed into growth
Poor cash management can lead to cash which could have otherwise been invested in the business’ growth being used to cover basic liabilities. This creates an opportunity cost as that money would have been much better spent on growth and revenue generation.
Not meeting profit potential
Without good visibility on cash flow, you can’t make the best decisions regarding profitability for your business. Strong cash management ensures you don’t overspend which means you’re more likely to remain profitable.
Using creditors or the ATO as a bank
If you’re holding off paying creditors or the ATO what you owe them, because you’re under cash flow stress, you might as well be using them as a bank. This can seriously damage relationships with suppliers. In the case of the ATO, it can mean you’re not compliant and quickly bring unwanted attention to your business.
Being forced to accept bad terms when raising capital
If you’re desperate and have run out of money, you may be forced to accept non commercial lending rates or poor equity terms to keep operations afloat. This can have a long lasting detrimental impact on the business.
Not planning effectively
Sound cash management influences various aspects of planning in your business. When you know when more cash is coming in or out it will influence spending decisions, will allow you to cost projects more accurately, will make you less likely to make bad investment decisions and give you greater clarity over when to increase or decrease director’s wages. Without this, you’re essentially flying blind.
At Keeping Company, we’re not just accountants, we’re business people too. With our counsel, your business can reach its full potential.
We have a team of experts; Cloud Accountants, Business Advisors, Finance Specialists working together and ready to help, contact us today.
For all media enquires please contact Tracy Miller, CMO, Keeping Company 0414 898 452.
The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.