Business Cash Flow Introduction

The following quote, popularised by Thomas Friedman in his book, The World is Flat, provides a metaphor for the competitive nature of business: “Every morning in Africa, a gazelle wakes up, it knows it must outrun the fastest lion or it will be killed. Every morning in Africa, a lion wakes up. It knows it must run faster than the slowest gazelle, or it will starve. It doesn’t matter whether you’re a lion or a gazelle, when the sun comes up, you’d better be running”.

Jack Welch, the former CEO of GE Inc, offered another perspective when he stated: “Cash is king. Get every drop of cash you can and hold on to it”. The phrase “cash is king” has become the poster boy, literally and metaphorically, for finance directors to communicate that key business processes must terminate in the bank.

Should a business approach a lender for a business loan to fund growth or provide additional working capital the lender will assess the ability of the business to consistently generate sufficient cash to meet its operating and debt obligations and will then regularly monitor that capability. Whether or not a business has an external lender as part of its capital structure, it makes sense to optimise operating cash flow. This business cash flow guide offers 12 practical steps to enhance business cash generation, irrespective of the sector in which you operate.

Operating Cash Flow

Let’s start with a definition of operating cash flow: the increase (or decrease ☹) in the amount of money a business produces from its core activities in a given cycle, usually a month, quarter or year. Specifically, operating profit adjusted for changes in working capital, maintenance capex and depreciation.

Steps to Improve your Business Cash Flow

1. Keep track of cash

Accurate and timely information is the lifeblood of business. One key performance indicator is the amount of cash available for operations. In established businesses with a developed finance function the Finance Director or Controller will have online access to the bank account and know daily the flow of funds and the current account balance. Most managers know their way around their financial statements but often overlook the most important section, the cash flow report which comes after the balance sheet. It’s here that the cash generating ability of the business is explained. It can be quite surprising. Know how much cash you generate and report it within your monthly KPIs!

2. Customer care

When your business is new and small you will celebrate every customer, and probably every order! As you grow, do you really want customers who constantly gripe about price, have high levels of returns or do not pay on time? Not every customer is a good customer! Some may be very costly to service. These may suit a different price structure or being carefully managed out of the business. Treat all customers well but understand their cost to serve.

3. Offer credit sparingly

For new accounts, if possible, agree payment in advance or prior to shipment. If you must provide credit terms, try net 7 or net 10 or end of month before offering net 30. Obtain a credit report from one of the credit agencies such as Experian, Creditsafe or Equifax and pay to monitor adverse reports to your key accounts. Try not to offer credit terms, but if you must, check your customer’s creditworthiness.

4. Aim for profit

There may be times to sell on a marginal cost basis or at a large discount but it’s not a sustainable strategy. A manufacturer with a 10% gross profit does not have a viable business model, assuming normal overhead costs. If it costs you £10 to produce and you’re selling it for £8, you won’t be in business very long. Configure your operations and business processes so that your product or service is at a price that covers all associated costs resulting in the desired profit margin. Profit is made up of two components, gross profit (revenues less direct costs) and operating profit (gross profit less overhead costs). Is your gross profit sufficient and sustainable? Know your costs, set & monitor gross profit and operating profit targets.

5. Price to win

Have you ever walked into an Apple store and wondered how they sell what are essentially commodity technology products at the prices on display? It’s because they do not set prices based on the manufacturing cost, although they put enormous effort into supply chain efficiencies. They understand that consumers are willing to pay for design, quality, brand and experience and those are difficult to cost. Your business may not be a leading brand, but it may be less price sensitive than you think.

6. Maintain a good cash flow forecast

Complex financial spreadsheets or business models can be intimidating but it is critical to know how income and expenditure will impact the business in the short, medium and longer term so that sensible decisions may be made. From a lender’s perspective, a well-managed finance function may be the difference between a positive lending decision and a decline. If your business is not able to manage and plan its own cash resources effectively what confidence will a lender have in your ability to service a term loan! If it doesn’t exist, develop a financial forecast model to track revenues, direct costs, overhead costs, cash receipts and payments. Ideally this should be integrated with your profit and loss account and balance sheet. There are many forecasting products on the market and most accounting packages have this sort of sophistication built in. Create and maintain an effective forecasting model and track its accuracy over time.

7. Purchase professionally

A typical manufacturing business will spend 30% to 50% of its revenue with a variety of suppliers, related to raw materials, production consumables, energy and overhead costs. Larger businesses will have a purchasing function focused on managing those relationships, the interface with operations, purchase transactions and associated cash flow. Purchase efficiencies are not just about achieving the lowest unit price. They include quality, delivery frequency, the need to carry inventory, design for manufacture and payment terms. Pay attention to purchasing.

8. Invoice efficiently

Send invoices promptly, accurately (including supplier references) and to the right purchasing/payment contact at the customer. Monitor payments and, where payment is not made according to agreed terms, act with a call, email or letter to establish why there is a delay and when payment can be expected. It’s not a sale until the cash is in your bank, so design an effective invoice and cash collection process.

9. Discount with caution

You might be surprised to know that if your gross profit is 50% and you offer your customer a 10% price discount, to make the same amount of revenue you will need to sell 25% more volume! At 30% gross profit, you’ll need an additional 50% more volume. That’s scary. There’s a place for discounts, usually related to preferred supplier commitments, contract length and volumes. Don’t ever let your sales team unilaterally offer them! You can be sure they will! Try and sell £1 for £1.10, not 90p!

10. Grab that cash

Days sales outstanding (also known as debtor days) is a key finance metric that highlights how long it takes for customers to pay. It’s calculated by trade debtors (or accounts receivable)/total credit sales x 365. The lower the figure, the better. Track the metric, compare it to other businesses in your sector to see if there is room for improvement and then make the necessary changes to improve policies, business processes and collection strategies. According to Bloomberg, in 2020 the average global Days Sales Outstanding was 66 days, so that’s a top-level marker to start your process.

11. Manage payments

The flip side of the DSO metric is creditor days, defined as trade creditors/cost of goods sold x 365. This can be a controversial topic in the UK as the Government takes a dim view of larger companies, especially in retail and construction, extending payment terms at short notice, on a unilateral basis. However, there may be some scope for aligning supplier payments more to the working capital needs of the business, but in a fair and transparent manner. Companies that value their reputation and credit agency status will strive to maintain agreed payment terms.

12. Reduce excessive stock

Many manufacturing businesses commit considerable working capital to raw materials, work in progress and finished goods. Each one is vital to meeting customer requirements but can be done efficiently or inefficiently from a working capital perspective. Stock (or inventory) turn is a useful metric to clarify operational working capital efficiency, defined as cost of goods sold/average stock value. The stock requirements of a food store will be different to a manufacturer of tanks, but both should strive to work towards the optimum level of stock. Many businesses achieve this through Just in Time or Lean Manufacturing programmes which can have dramatic benefits on cost, quality, lead time and inventory levels, leading to tangible cash benefits.

13. Improve key business processes and reduce costs

If your business operates through slow, complicated processes you will be burning unnecessary cash. It’s a longer-term effort but if you are not implementing JIT, Lean, BPR or Six Sigma improvement you are missing opportunities to run faster, with fewer defects and lower inventory. The efforts don’t have to be grand to have a large effect. A 1% improvement in revenues, gross profit and overhead costs will yield a 15%-20% profit increase and free up cash. How do you know if you need to improve? Take a look at a few of the working capital metrics mentioned earlier (DSO, Creditor Days and Stock Turn) to establish a base line from which to start. Working hard and working smart can sometimes be two different things.

14. Increase revenues

When you throw into the mix routes to market, product range, territories and pricing strategies increasing revenues can become quite complex. Assuming a business has customers, who wish to buy its product or service; revenue at its simplest is a function of price and volume so there are only 4 levers to pull: increase the number of customers, increase the average transaction size, increase order frequency and increase prices. Why don’t you spend some time with your team and brainstorm workable ideas for each one, and implement them?  If you’re not taking care of your customer, your competitor will!

15. Build a surplus

Many families operate a holiday fund in their domestic finances, keeping a little in reserve every month to provide funds to pay for a vacation. No matter how carefully you plan, budget, forecast and improve something can emerge unexpectedly. No one saw 2020 coming in 2019! It’s a great business habit to keep cash available for times when things do not go according to plan. That’s why some large and successful companies have cash balances greater than the GDP on many countries! The most cash-rich company in the world, Apple Inc, had $195.57 billion available cash at the end of Q1 2021! Keep 3-6 months expenses in a rainy-day fund, because as we know in the U.K., it always rains sometimes.

Why use a commercial finance adviser?

Whether you need growth capital to fund unexpected orders, or a strategic shift into a new product or market, or have a requirement for additional working capital to ease the cashflow pressure on your business there are good reasons to consider using the services of a specialist debt advisory firm, such as Blueray Capital:

1. We have good relationships with all the relevant lenders and know their lending criteria and application process requirements
2. Applications introduced by advisers are of more value to the lender than a direct approach. Lenders know that we will have already done due diligence on the client, established the transaction is robust, prepared relevant information and presented it in a lender-friendly format. We make the process easier for the lender and they trust us.
3. For good quality deals it’s likely that multiple lenders will express interest which provides the client with more choice and potentially enhanced terms. One of our key roles is to establish lender appetite quickly in the process and help achieve optimum terms.

Obtaining a growth capital loan usually starts with a conversation with Blueray Capital. We can efficiently assess the options available and, if mandated, work with you exclusively to present you in the best light to our funding partners and guide you through the process to a successful completion.