If finance and accounting were easy, there would be far more successful businesses operating (and thriving) in this country. It’s a point I made in Pt. 1 of this two-part series on tackling one of the toughest challenges facing any small to medium-size business owner: cash flow management.
In that last post, I noted a handful of the major contributors to cash flow mismanagement: losing sight of revenue, over-spending, over-hiring and not collecting on receivables. Perhaps the most daunting challenge I outlined is also the most common—not understanding the basic financial principles underscoring cash flow management. The reason is that very few entrepreneurs have formal accounting or financial backgrounds. They start and build businesses based on a core competency, then produce products or deliver services for a target clientele. For most, mastering the important details of effective management involves a great deal of on-the-job learning and, ultimately, trial and error.
Of course, some CEOs never fully understand what it takes to properly manage their books, which explains why so many organizations run into deep financial trouble at various stages of the business life cycle. The good news is that each of these hurdles can be cleared with a strategic approach to accounting and financial management. Here’s a summary of common cash flow-management challenges and how to overcome them:
Mastering cash flow basics
A cash flow statement is one of the most important financial statements for a project or business. The statement can be as simple as a one-page analysis, or may involve several schedules that feed information into a central statement.
A cash flow statement is a listing of the flows of cash into and out of the business or project. Think of it as your chequing account at the bank. Deposits are the cash inflow and withdrawals (cheques) are the cash outflows. The balance in your chequing account is your net cash flow at a specific point in time.
A cash flow statement is a listing of cash flows that occurred during the past accounting period. A projection of future flows of cash is called a cash flow budget. You can think of a cash flow budget as a projection of the future deposits and withdrawals to your chequing account.
A cash flow statement is not only concerned with the amount of the cash flows, but also their timing. Many cash flows are constructed with multiple time periods. For example, a statement may list monthly cash inflows and outflows over a year’s time. It not only projects the cash balance remaining at the end of the year, but also the cash balance for each month.
Working capital is another important part of a cash flow analysis. It’s defined as the amount of money needed to facilitate business current or ongoing operations and transactions, and is calculated as current assets less current liabilities (liabilities due during the upcoming accounting period). Calculating the amount of working capital gives you a quick analysis of the liquidity of the business over the future accounting period. If working capital appears to be sufficient, developing a cash flow budget may not be critical. But if working capital appears to be insufficient, a cash flow budget may highlight liquidity problems that could occur during the coming year.
Confused, or even worried that you might never master the art of cash flow analysis? Don’t be, at least not if you employ the services of a qualified accountant or CFO who can help interpret relevant financial information. What’s most important is your ability to read a cash flow statement and balance sheet, then make strategic decisions accordingly. Leave the rest of the heavy lifting to your finance department and trusted advisors.
Keeping track of revenue
Forecasting revenue is crucial to any cash-flow statement. Pay particularly close attention to seasonal fluctuations in revenue, which can affect the timing of future cash flows. For example, a business that depends on selling product to retailers for the Christmas season will generally build up inventory into the late summer, and invoice clients in early fall. The bulk of the company’s revenue could very well be generated during the period lasting from July to October. That could cause a cash flow crunch for the rest of the year if finances aren’t managed properly.
Companies need to distinguish between discretionary and non-discretionary spending. That’s a fairly simple task when it comes to rent, office overhead, wages and inventory purchases. But the distinction can become blurred when accounting for other expenditures, such as marketing, advertising or promotion.
Is it vital to attend a business conference at a luxury resort, or spend money on hockey tickets to wine-and-dine potential clients?
A best practice is to develop an overall business marketing plan, then work with a specialist in that field. Identify your target clientele and develop a marketing strategy that addresses your organization’s budgetary realities and helps promote your products or services to those prospective customers. Set goals and expectations for the marketing initiative and develop tools to measure outcomes. That way you can turn otherwise discretionary expenditures into vital initiatives designed to build your business.
It’s not an easy task to manage the hiring of staff. Over-hire and you run the risk of being saddled with contracts and long-term liabilities, or even incurring expensive termination costs. Further, as an employer you are responsible for your portion of employee benefits such as employment insurance, pension and workers compensation, which could add another 15 per cent to 20 per cent to payroll costs.
A good way to manage this would be to hire some of your staff as independent contractors. They invoice you for their time and you’re not burdened with added payroll costs. You only pay when you need their services. These days you can contract with organizations that will provide you with a part time CFO and marketing person, in addition to bookkeepers and secretaries, just to name a few important positions. You will know soon enough whether that person is a right fit for your business and whether your business can absorb related wage and benefit costs on a full-time basis.
But one word of caution: the CRA has rules preventing companies from hiring workers as independent contractors when they would otherwise be defined as employees. As such, independent contractors should have more than one client, should be in charge of their own schedules, and own their own tools and equipment, among other criteria. If not, they may be deemed employees subject to protections under the Employment Standards Act, including an obligation to pay the government-mandated employee benefits.
Make sure you seek professional advice from your tax accountant before heading down this route.
Every company has them … past-due and slow-pay accounts. Our experience shows that of every 10 new customers an organization acquires, six will pay on time, two will pay in 60 to 90 days and two will become collection problems. This means that up to 40 per cent of your new clients could put (at least a temporary) dent in your organization’s cash flow. Should you stop searching for new customers? Obviously not. Those statistics simply underscore the need to be proactive when it comes to invoicing and collections. A few tips include:
- Being familiar with your customer’s credit history—Only extend credit to organizations you feel confident will pay. Make sure you don’t have to write off your hard-earned sales through bad debt! And always ask for a deposit from any new client.
- Paying close attention to the credit terms offered to customers—One good way to collect is to do so before you deliver your product and structure your terms accordingly.
Examples of accounts receivable payment terms:
For custom manufacturing companies—50 per cent payment before work begins, 40 per cent before delivery and 10 per cent after delivery
For wholesalers and retailers—Depending on creditworthiness, 10 days net for companies with good credit; payment prior to delivery for companies with questionable credit or those that are past due
- Define the minimum sales order amount that will require a credit check
- Check three references for each new client
Last point, be sure to invoice promptly—ideally within 24 to 48 hours after delivering a product or service. Always review invoices for accuracy, ensure all products and services have been billed and clearly note payment terms on the invoice.
Most importantly, never take your eyes off your organization’s financial dashboard. Review cash flow statements regularly and maintain strong communications with your finance team. The trickiest part of managing cash flow is that a crunch can emerge quickly, which only underscores the need to monitor key financial metrics on a regular basis.
Hartley Cohen, Partner