Most of the times, a lot of startups are forced to go under not because the particular sector of the economy where they are launched is bad. The market may be booming, government policies may be right, timing may be just perfect, yet some businesses will still pack up. A business can even be profitable but be struggling to meet obligations to creditors or pay bills as they fall due. How can these things be? Well, when the above scenarios play out, the issue is largely a result of poor cash flow management.
You must have heard of the saying, "cash is king". YES! Cash or cash equivalent is not only king but the lifeblood of any business, especially the Micro, Small and Medium Enterprises (MSMEs). If your business does not have sufficient cash to settle its obligations as quickly as possible, be rest assured that the business is heading for doom. What then is cash flow and how can it be properly managed to ensure the success of any business?
Simply put, cash flow is the movement of cash and cash equivalent in and out of a business within a given period. As simple as it seems, knowing the amount and timing of the movement and adequately planning for it is critical to the survival of the business. To stay afloat therefore, a business owner or manager must understand the company's cash flow and then put measures in place to ensure the availability of cash for its operations at all times. This entails monitoring, analyzing and forecasting the business' operating, investing and financing activities for a given period. Any of the activities- operating (normal course of business), investing (assets acquisition, expansion, etc) and financing (funding)- can lead to either a net positive cash flow (excess cash inflow) or a net negative cash flow (excess cash outflow). To avoid a cash crunch situation, the company is expected to prepare what is called a cash flow projection for a specific period. The cash flow projection, if properly done with a deep understanding of the company's operations and strategic focus, will act as a compass that would point out when the business needs fresh cash injection in the short or long term and when there will be excess cash. See example of a simple cash flow projections for a trading company, Emochris Nig Ltd, below.
The projected cash flow from table 1 revealed that Emochris Nig Ltd will have difficulty meeting some of its obligations for two consecutive months. Except urgent steps are taken, the business may cease to exist within the next few months. This is because suppliers will stop credit sales if they can't get payment after two successive due dates. Employees will start searching for new opportunities, may be in a competition's company, if they don't get paid after two months with no hope in sight. Customers will eventually notice and move their purchases elsewhere
However, having identified the potential problem, the company can put measures in place to address them before they show up. As shown in table 2 above, our hypothetical company, Emochris Nig Ltd took three decisions that changed the direction the company was heading. (i) they immediately approached a bank to negotiate a loan, (ii) they reviewed their credit sales policy, with a view to moving towards cash and carry sales, (iii) they renegotiated their accounts payable allowable period with their creditors. These decision immediately transformed the company from a cash strapped organization heading for collapse to a viable company with a healthy cash flow.
Businesses, especially startups and MSMEs, can take the under listed steps to address cash flow problems.
- Increase sales: Generally, it is expected that as sales increases, more cash will flow into the business. Therefore, if your business is having challenges settling fixed costs for instance, you need to find ways to increase sales.
- Review credit sales and Account Receivable policies: A company with cash flow problems needs to consider reducing its credit allowable period offered to its debtors or out-rightly shift to cash based transactions. However, the customers have to be carried along before implementation.
- Negotiate favorable Accounts Payable terms: The business can renegotiate more favorable repayment terms with its vendors and suppliers or look for new ones with better terms.
- Take a loan: Depending on whether the cash flow problem is coming from operating or investing activity, the business can take either a short-term or a long-term loan or even an overdraft to stay afloat. However, banks have conditions that must be met before accessing any type of loan. Therefore, it is advisable to find out from your bankers before you need one.
- Disposal of obsolete assets: A company may have funds tied up in equipment or inventories that are no longer useful to it but which can be converted to cash. Selling off such assets will not only rake in the much needed cash but also save the business the cost of keeping such items.
This list is by no means exhaustive. I would like to hear how you were able to address your cash flow issue(s). Share your experience(s) using the comment box.