7 ways to avoid a cash flow crunch

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Cash flow is one of the leading causes of small business failure – and lost sleep. According to 2013 research from accounting software provider CCH , 61 per cent of SME (small and medium enterprise) owners said they believe small businesses fail because they cannot manage costs. And when the economy is volatile or soft those pressures can escalate, if revenue falls or debtors fail to pay within trading terms.

So what can you do to proactively manage the natural ups and downs of business income? Jeff Davis, Macquarie's Head of Credit and Risk Analysis, shares his seven tips for smarter cash flow management.

Look at the best case, likely case and worst case scenarios. Put contingencies in place: use the ‘if then’ planning approach
Jeff Davis, Macquarie

1. Recognise cash is king

"There's a saying 'revenue is vanity, profit is sanity, and cash is a reality,'" says Davis. "Cash  is what you use to keep the business going and what you take home – and that's why it's so important."

Here's an example of the impact cash can have. If your annual business revenue is $1 million, and your average debtor collection repayments shift from 30 to 60 days because you take your eye off payables, you'll have an additional $80,000 in debtors that hasn't been converted into cash. Unfortunately, you still need to pay salaries and bills – so where will that cash come from?

2. Identify the true cause of cash flow pressure

If your business revenue is seasonal or uneven, or if you have a highly concentrated client base, you may find cash will become tight at certain times.

"Some businesses have a high fixed cost base and tight margins, which gives them little room to cut costs as demand varies," says Davis. "Or they may have long payment terms and issues with debtor collection. All these scenarios can create cash flow issues."

3. Find ways to even out your income

While it's good business sense to focus on your core business offer and strengths, it's also smart to create 'backup' service options – essentially, a way of making sure not all your eggs are in one basket.

In the UK, research from The Economist identified diversifying products and services as the dominant SME strategy to build resilience – undertaken by 63 per cent of SMEs. Additionally, 62% have diversified their customer base and market presence.

Davis says the ideal scenario is to have as much income as possible on contracted or recurring terms, with that revenue covering most (if not all) your fixed cost base.

"For example, we've seen some of our most successful real estate clients cover their bulk fixed cost base with contracted and recurring property management fees," he explains. "That makes them less susceptible to the vagaries of the economy, with its impact on the property market and in turn their sales income."

This strategy is enhanced by an ability to make more costs of sales variable. "If their sales income slows, so do their costs – it's a good example of matching fixed costs with fixed income, and variable costs with variable income."

4. Stay one step ahead with technology

Davis says new technology enables better cash flow management, but it can also potentially cause greater volatility in income. "The information age is great, but it creates uncertainty – and that can be harder for small businesses to ride out."

Online and cloud-based accounting systems make it simpler for business owners to get real-time visibility of their cash, and reduce the time it takes to proactively manage and forecast cash flow. So make the most of these tools – but be mindful that other types of technology are likely to cause disruption in your sector. And disrupted business models can also mean disrupted future cash flow.

5. Prepare for all scenarios

The most important thing you can do is forecast your cash flow regularly. "Look at the best case, likely case and worst case scenarios, and actively monitor your actual position compared with your forecast position," explains Davis. "You need to put contingencies in place: use the 'if then' planning approach because if things don't go as planned you already know exactly what to do."

6. Do due diligence on debtors

According to Dun & Bradstreet, more than $19 billion is locked away from Australia's businesses because it's beyond the widely accepted 30 day payment term. Given your customers could be a risk to cash flow, it pays to assess that before you start work.

"We talk a lot about the 'character' of the people we lend money to, and it's no different for any other business," Davis comments. "You've got to be comfortable with who you're doing business with – do some online research, talk to others in the industry, and be aware of your 'gut reaction' when you meet them."

Upfront payment options and progress invoicing can help you bring your cash flow forward.

"If you're in a cash intensive business, make sure someone in your business is actively monitoring and following up outstanding debtors. The longer it takes for repayment, the more likely you are to end up with a bad debt."

7. Cash flow funding is not a default option

While a cash flow loan is one option, it's not always the best strategy for long-term cash flow management.

"It's important to differentiate between a genuine cash flow or timing issue, or problems that have arisen from poor trading," explains Davis. "If you know cash is eventually coming in, funding can be a good solution. But if you're using it to cover losses, you're eroding the equity in your business."

Ultimately, you need to find a sustainable solution for your business – or risk becoming another cash flow statistic.

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This material has been prepared by Macquarie Bank Limited ABN 46 008 583 542 AFSL & Australian Credit Licence 237502 ("Macquarie") for general discussion purposes only, without taking into account your personal objectives, financial situation or needs. Before acting on this general information, you must consider its appropriateness having regard to your own objectives, financial situation and needs. The information provided is not intended to replace or serve as a substitute for any accounting, tax or other professional advice, consultation or service.

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