The age-old statement of cash is king remains true for all businesses but more specifically for small and medium enterprises (SMEs) given the challenging economic environment that SMEs operate in.
Businesses need to differentiate between profit and cash flow. Many businesses are profitable, yet run out of money due to ineffective cash flow management. Many businesses generate substantial profit during a month as a result of orders or sales, but as payment often isn’t due for another 30 or 60 days, they struggle to continue operating, as they are unable to meet operating expenses or pay staff salaries. For businesses to avoid finding themselves in this situation, owners need to be aware of a few key areas that could result in cash flow problems.
Credit control: It is crucial to have strict credit policies in place, as poor credit control can result in a business not receiving payment on time and in turn, could lead to the business defaulting on its obligations. It is also important to remember that larger enterprises often take longer to process invoices, which sometimes needs to be taken into account as late payment can have a drastic effect on SMEs. Analyze cash flow impact of offering customers discounts for early payment.
Order fulfillment: If a business doesn’t deliver its products or services on time, the invoice will not be paid. Once a product has been delivered or service rendered, the bill should be issued promptly. Deposit checks as soon as they are received to avoid delayed clearing.
Other factors that could lead to cash flow problems include inefficient ordering systems, poor management accounting, inadequate supplier management and lack of control over gross profits or overheads.
The essence of successful cash flow management is the regulation of all money flowing in and out of a business. An increased, consistent cash flow will create a predictable business pattern, making it easier for a business to plan and budget for future growth.
The following tips can help business owners on how to increase their cash flow:
Take advantage of early payment incentives: If you have cash available, take advantage of the discounts offered by suppliers, as a 2% discount on a 30-day invoice is equal to a 24% annual return if the money was invested. Also, enquire with all your suppliers as to whether they can offer a discount.
Balance your client base
: Many service and professional companies, for example, accountants and lawyers, work with certain clients on a project-by-project basis. Convert these clients to a retainer relationship by offering some kind of incentive or value-added service. While this may reduce profit margins, it will make cash flow more predictable.Check your pricing
: Review your prices regularly in order to ensure that they are aligned with rising costs. Ensure you also monitor your competition on a consistent basis, if they are charging higher prices, then perhaps you should too. Form a buying cooperative
: Although you may be in competition, sometimes it makes more sense to do joint buying and buy in bulk with colleagues and/or other businesses in order to save on volume purchases. Large volume buyers are able to negotiate better prices.Renegotiate insurance and supplier policies
: Review insurance policies annually and regularly examine bills to ensure you are getting the best possible deal. Ensure that you keep a close eye on price sensitive services, such as internet and telephone access, as these can often change.Tighten your stock
: Some SMEs think they make more money by keeping unnecessarily high stock levels. While this drains your cash resources, it also creates other problems of obsolescence, pilferage, and opportunity cost. Reduce overstocking by calculating your business inventory turnover ratio (cost of goods sold divided by the average value of your inventory) and compare this with the industry norm. Be sure to cater for peak seasons and take account of lead times. Consider leasing instead of buying
: Leasing generally costs more than buying, but these costs can often be justified by the cash flow benefits. Lease payments also have a tax benefit as they can be claimed as a business expense.Stick to your budget
: It goes without saying – avoid overspending.
Eric Rutabana is the Chief Investment Officer of Business Partners International Rwanda SME Fund, a risk Finance Company for formal SME’s