The Capital
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The Capital

Cashflow is still the King — Manage it well

This is a general guide to post-pandemic business management.

Cash is not the king. Cash is trash. It loses 5 to 10% of its purchasing power every year. Cashflow is the king. It's all about how that cash flows in and out of the business. Why should cash flow out? Because it is very hard to make money without spending some money. Cash should flow in because you are running a business to make as much money as possible.

How cash flows in and out of the business is a process that needs to be managed. Failing to manage cash flow can easily lead to the death of the business. There is nothing new here. What was prevailing before the pandemic continues after the pandemic. Given that so many businesses make missteps and mistakes in managing cashflows, there is a need to emphasize the importance of managing the cashflows well.

In my years of consulting, I have observed that even though cash flow management techniques are detailed in many books and articles, very few business managers purposefully set out to manage cash flow. Oftentimes cash flow management is done as a firefighting exercise, only invoked when the company is already experiencing cash flow challenges. Another observation is that when managing the cash flow, most managers make use of a few working capital management techniques.

The most prevalent techniques deployed are 1) aggressively chasing debtors and 2) defiantly delaying supplier payments. Both of these typically result in disruption of business as both customers and suppliers get agitated and the relationship turns sour, invoking the need to be mended later when cash flows have stabilized.

Ways to manage Cash Flow

  • Build a buffer — it’s not wise for a company to live from paycheck to paycheck.
  • Minimize the use of Overdraft Facilities (a.k.a Payday loans).
  • Only purchase assets using equity capital, debt, or free cash. If you don't have these things, it's not wise to buy fixed assets.
  • Working capital management —creditors, inventory, debtors, Opex.
  • Deploy techniques of matching payment patterns to receipt patterns.

Building a Buffer

In good times, companies forget the need to build a buffer that can shield them from tough operating environments in the future. When your company finds itself with some free cash, do not rush to think of what projects you can invest in before thinking of stabilizing current operations. Build a chest of liquid investments on the balance sheet that can be used in times of trouble.

The same advice that is given to individuals applies to companies. Individuals are advised to have at least liquid funds that are enough to cover 6 months' worth of living expenses. It's a pot of funds for the rainy day. Very few companies follow this advice because they prefer relying on a credit line available at the bank should they need funds. This is not different to the individual that relies on a credit card.

A buffer will make the business resilient. It will stabilize cashflows. If the biggest credit customer does not pay on time, the business manager will not panic if there is a buffer. A badly managed company can delay paying salaries because the largest client did not pay on time.

How do you build a buffer? Self-discipline is hard. Only a few companies can be able to do that. Our weaknesses at the individual level get compounded at the corporate level. Humans are generally bad at self-discipline. This explains why only a tiny proportion of the community exercise regularly. The queue at KFC is always longer than the queue at the gym.

As a corporate manager, systems and processes ought to protect you from your own weaknesses. But you have to build those systems, and that is the main source of weakness.

Which systems can you put in place to ensure that you forcibly build a buffer:

  • Fixed deposit accounts — arrange with your banker, the company will not be able to withdraw from that deposit for at least 6 months.
  • convert the bonds on commercial property to access bonds and stash some funds in there.
  • implement a rule that new expenditures can only be authorized if the buffer is above x dollars. Violating that rule would be coded as a failure on the business manager's core KPIs that determine his or her bonus.

Minimize the use of Overdraft Facilities

An overdraft facility for the company is not very different from a payday loan extended to an employee. It traps you in the cycle of debt. Interest in an O/D facility is typically high. You burden the business with high interest, and you also force the business to live from paycheck to paycheck.

There are legitimate times when an overdraft facility is required. However, businesses that typically make use of overdraft facilities don't really use them in times of need. They use it on a continuous basis. Why is that so? It's the same problem that drug addicts have, addiction. You get hooked; it becomes very hard to wean yourself off the addiction.

As a business manager, do not attempt to manage the cash flow by making use of an overdraft facility. That is not how a cash flow is managed because it does not address the root problems that have led to cash flow problems that have now led you to require an overdraft facility.

Source of Funding for Fixed Assets

Long-term assets should be funded by long-term sources of funds. In a business, this list has equity capital and long-term debt. On equity capital, this should specifically be free cash flow generated by the business. The definition of equity capital should not literally be taken as retained income because retained income as listed on the balance sheet is an item that includes non-cash items, and some of the retained income could already have been utilized in financing assets that have corresponding values on the asset side of the balance sheet.

The business manager must redefine the calculation of free cash. To that end, he should take retained equity since inception and add back the non-cash items deducted previously from that retained profit. The resulting figure is cash generated from operations. The next step is to figure out how this cash was utilized. The answer is on the asset side of the balance sheet (i.e., assets that were not financed by debt). When you find these assets, you subtract them from the cash flow generated from operations. What remains is the cash that can be freely used by the business. If this number is negative, the business has freely used more cash than it had generated from operations.

If you are a start-up, fund the acquisition of your fixed assets with fresh capital injection. Established firms should make use of debt if they don't have enough free cash flow.

Trying to use free cash flow for acquiring fixed assets is a monumental mistake that ties up cash in fixed assets, leaving very little working capital room to smoothen the operations.

Working Capital Management

Everything that needs to be said has been said already in most finance books. The most common mistakes businesses make in this regard are as follows:

  • debtor payment terms that are way too gracious and out of sync with supplier terms.
  • poor debt collection — some customers don't pay you if you don't chase, it's a flaw in human nature.
  • overstocking — holding too much inventory — cash tied in inventory.
  • unreasonable supplier terms — C.O.D for goods that are normally sold on credit, or 15-day terms for an industry generally dominated by 60-day terms.
  • Cash is withdrawn from the working capital cycle to fund the owner's luxurious lifestyle and eccentricities.

The point regarding gracious debtor days is a common problem in FMCGs and retail. The big retail outlets that typically monopolize retail trade occasionally buy from smaller suppliers. They ruthlessly squeeze these little guys with absurd terms. They pay the small guy after 90 days, whilst the small guy has to pay his supplier within 60 days. At the same time, these big retail outlets pay bigger suppliers within 30 days. This is outright bullying. Smaller guys have to collectively come together and fight against this abuse of market power by pushing for regulation requiring fair treatment.

Other than that, business managers for the smaller guys have to generally ensure that supplier terms are in sync with debtor terms. Too many businesses make this schoolboy blunder. Your business is better off without that big order from that big supermarket that will cripple your business due to cash flow challenges for the three months that you wait for them to pay. The sleepless nights, employees bitching about their salaries, the landlord sending emails for rent overdue, et cetera, all because of one giant order.

Matching Payment Patterns to Receipt Patterns

As a business manager, you have to take cash flow seriously. This means you must find ways of matching payment patterns to receipt patterns. The matching of supplier terms to debtor terms is a broader example of this.

On a much narrower basis, you have to profile your payments. The average company has a bunch of payments clustered around month-end. Receipt patterns differ by company. Some receive the bulk of their receipts around month-end, as customers spend their income, whilst some have sales that are scattered all over the month (e.g., hardware sales).

Matching payment patterns is not crucial if the company has a very healthy cash flow. Only a few companies can be described as such, thus, matching payments to receipts becomes general advice.

The typical payments scattered around month-end are as follows:

  • Sales Taxes, VAT
  • Payroll
  • Rent
  • Debit orders
  • Supplier payments

These are normally paid between the 25th of the month and the 2nd of the following month. The average company runs around for cash during these days, ensuring that there are enough funds to cover payroll and debit orders. The struggling firm then arranges a soft loan, to be repaid a couple of weeks later after receipts flow in. It doesn't have to be so.

Reconfiguring the payments profile might mean deliberately changing the payment dates so that most of them are not clustered around one date. Your intuition can trick you into believing that this does nothing to the cash flow because you have to make the payments anywhere. Cash flow, because it is a flow metric, rather than a fixed, constant metric, is an area where sequence matters.

Think of the lounge or bedroom arrangement of your house. There is a certain time that you rearrange the furniture and boom you suddenly have enough space. The floor area did not change but you now have more legroom and more free spaces.

If the company is already in a tight cash flow situation, it should reconfigure the payment patterns first before going for an overdraft facility.

Examples of reconfiguring payment patterns:

  • Pay rent and other expenses in the middle of the month
  • Move all debit orders to the 7th instead of the 1st
  • etc

Huge outflows should be matched with huge receipts. Timing is of the essence.

Ciao!

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