Business statistics are heavy with the reasons that businesses fail.
Running out of cash is almost universally cited in the top five, if not top three reasons for failure. And this is true for businesses of all sizes, even those that have secured significant investor funds but subsequently failed to manage them appropriately.
A recent survey of small business owners by RUOK found that 32% of their respondents worried about their business finances to the point where they were losing sleep.
Management of cash, and business liquidity, is definitely a worrying aspect for many founders. In recent weeks I have seen a number of posts and articles relating to “Cash Management” or “Cash Flow Forecasting”, which is heartening.
The concern for me is that these commentators are pretty much all focusing on tactics to manage:
- supplier terms and payments
- trade debtors, and
- inventory levels.
Whilst these areas are, without doubt, important areas to manage; very few authors mention cash itself or the other key component of Working Capital, Short-term Liabilities. These areas omitted, in my humble opinion, go straight to the heart of the reasons why businesses run out of cash and fail.
A big caveat to the rest of this article is that I am talking of those businesses that have generated some market traction and are producing revenue. Pre-revenue startups, and early stage businesses, have a different set of problems mainly related to generating cash flows rather than managing the ones they have.
The purpose of cash in a business.
Cash is the ultimate form of liquidity in a business. It is there to:
- service day-to-day business requirements
- pay financial obligations when they become due
- provide a buffer to de-risk any unforeseen circumstances, requiring a quick turnaround.
The second point is the one I’d like businesses to focus on here.
Financial obligations are the immutable payments you need to make to stay in business. They include:
- Employee wages and salaries
- Employee obligations such as payroll taxes, insurance payments, superannuation payments
- Sales taxes collected on your sales (VAT, GST, Sales Tax)
- Short-term (within 12 month) debt repayments
- Paying suppliers for materials/product/services provided (identified separately as trade creditors)
Failure to pay these obligations when they are due can lead to a pretty quick fall from grace as a business and may ultimately lead to its demise. Failure to pay can indicate that you’re trading insolvently .
So where is the problem?
The list above gives a few clues as to where businesses tend to get into trouble; particularly where they are in growth mode.
When you are growing you will need more resources; more employees, more warehousing, more vehicles, more inventory, more, more….
Resources have a cost attached to them and a cash requirement to service them.
As you build your team, the step-costs of employing, training and on-boarding each employee will show a time-lag between them actually arriving and providing you with the return you expect. But their wages and employment obligations will be due from day one.
As you grow you’ll have a need for greater capacity – which will vary from business to business. Maybe inventory or vehicles or office accommodation. Many businesses are reluctant to use different forms of funding to fund different forms of capacity.
In fact, I was approached earlier this year by a ‘successful’ business who had run out of cash and was at the point of struggling to pay the wages bill. On a rudimentary inspection I found they had used their cash reserves, and credit cards (!), to fund new vehicles and a new purpose-built warehouse facility. As they grew their cash-cycle lengthened, particularly due to their push into export markets, and they quite suddenly found themselves needing to re-finance their business.
This was a perfect example of a business that had used the wrong type of funds (cash) for the wrong purpose (capital resources). Their ongoing success put too much pressure on their available Working Capital for the business to be sustainable in its current form.
To be able to meet the immutable obligations of your business you need to have them in clear view and locked-in to your weekly and monthly cash requirements.
Cash-flow management is a bit of a buzz-word, and I wish commentators would contextualise it within managing Working Capital. It involves developing forecasts of cash requirements based on your activity levels and your particular business model over a period of months. It incorporates those tactics you want to employ to manage your debtors, creditors and inventory as the volumes and value of transactions increases.
It also acknowledges the type of expenditure you are undertaking. It indicates where cash is either the appropriate funding source, or where it is more appropriate to use other sources; such as bank loans or an injection of capital as examples.
- Cash Management is more than trying to improve your commercial relationships with suppliers and customers, and optimising your inventory levels.
- Cash has a specific purpose in a business.
- Capital expenditures should rarely be funded with cash (unless your business is extremely cash-generative, in which case you probably wouldn’t be reading this article).
- Develop a forecasting model to be able to predict your cash requirement patterns, and any pinch-points that will emerge, as a result of your business activities. (Could be as simple as an excel spreadsheet).
- Review your forecasting model weekly if possible, monthly at a maximum. They are never totally accurate and require a little ongoing ‘fettling’ to accommodate the unforseen movements that all businesses experience.
- Think about your tactics for ensuring that you always have enough cash at hand to pay those immutable obligations.
Cash flow for Early Stage businesses.
As a footnote, it is worth noting that start-ups and early stage businesses face a few different challenges, namely:
- Generating reliable and consistent revenue and cash flow can take time to establish and the need for appropriate cash reserves, a ‘runway’, is a necessity to drive the business forward.
- Because of lack of history and credibility in the market, early stage businesses often struggle to get credit terms from suppliers; usually needing to pay cash-with-order for their supplies, for MOQs that are larger than their immediate need, and therefore end up with more stock than they want.
- Similarly, access to bank funding may be difficult due to the same lack of history and track-record.
- In the drive to build market traction and gain sales there may be a tendency to offer payment terms and/or discounts to prospective customers.
These pressures are very strong on start-ups and early stage businesses. To address them to a certain point it is important for business founders to closely manage the resources they do have and to be able to forecast and manage their cash requirements.
In my experience, those founders who can demonstrate they are on top of their numbers, have a robust model to show to funding providers; giving a sense of confidence in understanding their business finances, will have two benefits:
- They will more quickly be able to access funds to develop their business
- They will sleep better at night, with less concern about what they don’t know.
#cashflow #businessplanning #workingcapitalmanagement
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