Any company, large or small, needs to manage its cash flow well, as well as its sales and expenses. There are many giants that were apparently doing very well with strong sales growth and running massive projects, spending lavishly on research and development backed up with ad campaigns, only to see them collapse almost overnight. What is the reason for these unexpected crashes? Since they told us their sales were doing well and expanding, then the root cause has to be poor cash flow management. Cash flow is the difference between your receipts and payments (in cash, whether from bank accounts or from another source). Cash flow should not be confused with income and expenses or profit and loss, which is very different from receipts and payments.
To illustrate the difference between income and expenses (earnings) and receipts and payments (cash flow), let’s take a simple work example. A small business gets a contract for $1,000,000/- and they estimate their production cost to be only $225,000/-. The company is very upset at the prospect of making almost a 350% profit on its new contract. With much fanfare, jubilation and congratulations from all sides, the contracts are signed; product is manufactured and delivered to the customer in January. Being a small company operating on a modest budget, it had to borrow from banks at high interest rates for the purchase of raw materials, etc. for this operation.
The client pays only in July, which is six months from now. The small business, in its eagerness to win the deal at all costs, had poured all its resources into this special project, and with high monthly interest payments now due to lenders for the next six months until they receive their payment from the supercontractor. to pay the banks, and unable to obtain more loans, he gradually finds himself unable to meet his normal monthly commitments for rent, fees, wages and salaries, etc. or keep the production lines running for the manufacture of their normal products and supplies already agreed to other customers, even in their smallest quantities. So the company inevitably collapses, why?
Simply because they didn’t bother to see how their cash flow would perform during the interim period between spending and receiving money; concentrating solely on making a huge gross profit of $775.00/- on a single contract.
It would be seen that “overinvestment” beyond their means led to the earlier crash. If it had been a larger company with more assets and resources, it could have gotten away with using its surplus resources during the period that they had to wait for liquidation by the contractor. Therefore, smaller companies are seen to be more vulnerable to cash flow problems than their larger counterparts. The following tips should help you avoid similar disasters by managing your cash flow well.
Quick Debt Recovery
You must have very good control over granting credit to clients in terms of time and a maximum limit, always trying to collect your debts as quickly as possible so that you can enjoy the benefits of having more working capital. Getting your customers to order online or by fax could help speed up the pickup process. Make sure that you send the invoices together with the goods and that the payment due dates and the applicable penalty interest rates in case of late payments are clearly stated on them.
Formulation of a firm Policy for the Extension of Credit and Collection Facilities
Each client should receive credit facilities on their own proven creditworthiness merits, possibly in consultation with rating agencies; or asking the client to provide references. Follow up on all late payments immediately with a phone call or letter or both, otherwise legal action for debt recovery may be contemplated. Restrict additional supplies to a debtor whose account has become delinquent, until all delinquent balances are settled.
Go along with minimum balances in your operating bank accounts
Having a good cash flow position does not mean carrying excess or surplus funds in your operating bank accounts. Instead, judiciously divert some excess funds to repay any loans taken out at high interest rates and simultaneously invest in high-interest-earning fixed securities or short-term demand deposits depending on your liquidity position, i.e. your availability of available cash in bank accounts. short-term deposits, good recoverable debt, etc. along with estimated cash inflows and outflows for the next two to three months.
The pulse of any business is its cash flow. Therefore, strive to keep it at optimal levels of demand at all times, no more and no less.
