Here’s how to make sure you don’t run out of cash…

Here’s how to make sure you don’t run out of cash…

Is your business profitable on the surface, but you find yourself struggling to pay the bills? It’s a challenge many business owners face, and one that needs to be solved if you want to stay on track. I’ve seen it happen time and time again. Recently a SME, who was turning over R3-million per annum, came to me for advice because the company’s directors had been unable to draw a salary for five months. Not a cent.

How is this possible? A strange and scary financial term – working capital management – is to blame. Simply put, it’s a case of bad cash management, where shortages in cash flows are not anticipated and appropriate arrangements are not made in advance. Cash is the lifeline of a company, if it dries up so does your ability to fund operations, pay debts, reinvest and make payments.

What is the worst that can happen? Your business can go under, even with an annual turnover of a few million, or a turnover of a few hundred million. Businesses that are in danger look profitable on the surface, or on their annual reports, but are in an illiquid state. They do not have cash available for operations or emergencies due to funds being tied up in the cash conversion cycle (another scary financial term, which is explained further on).

Working capital is the cash your business requires to fund day to day operations, to turn raw goods or resources into products or services. Working capital is the difference between your current assets and your current liabilities. You want your working capital to increase, resulting in more cash flowing in, which can be used to run your business.

Signs you may be in working capital distress

  • Cash too low. Not enough cashflow to service operations?
  • High levels of Inventory. Are you tying up too much money on inventory and storage costs?
  • High Trade Receivables (Does a lot of clients owe you money?). Your business is not collecting cash for orders quickly enough, resulting in a shortage of cash.
  • Trade payables (do you owe a lot of money?). The aim is to lengthen the payable days enough to be in your advantage, but not to cause bad faith with suppliers.

In practical terms this can happen if you sign a large contract on 60+ days payment terms, or pay a large deposit for goods ordered. In effect, you are spending money to deliver a service or product now for which you will only be paid at some point down the line, maybe even three to four months later. As a result, you are constantly in overdraft, and do not have capital available for organisational growth. The results in an unhealthy working capital cycle; your current liabilities are more than, or close to, your current assets, and your cash conversion cycle is too long.

How to Fix it

One way to tackle this problem is by shortening your cash conversion cycle; or the number of days from the time you pay out cash for raw materials until you receive cash for the finished goods sold. A cash conversion cycle consists of the following:

  • Inventory days/days inventory outstanding (DIO)is the deposit paid or the days that you own a product, room/venue booking, shuttle/service before selling it.
  • Accounts Receivable days/days sales outstanding (DSO)is the terms agreed with your clients as to how long you have to wait for payment.
  • Payable days/Days payable outstanding (DPO)are the supplier terms dictating how long you can wait to pay/what your credit terms are.

Let’s look at a simple example:

You buy a product from a supplier on 30 day credit (=30 DPO), it sits on your shelves for 20 days (=20 DIO) before you sell it, and then the purchaser takes 35 days (=35 DSO) to pay you.

Cash conversion cycle = DIO + DSO – DPO

Cash conversion cycle = 20 + 35 –30

Cash conversion cycle = 25 days

This means that it takes 25 days for you to convert cash to cash, during this period you will need to self-fund your business, this is also known as the self-funding gap.

Here’s how to make sure you don’t run out of cash…

Is your business profitable on the surface, but you find yourself struggling to pay the bills? It’s a challenge many business owners face, and one that needs to be solved if you want to stay on track. I’ve seen it happen time and time again. Recently a SME, who was turning over R3-million per annum, came to me for advice because the company’s directors had been unable to draw a salary for five months. Not a cent.

How is this possible? A strange and scary financial term – working capital management – is to blame. Simply put, it’s a case of bad cash management, where shortages in cash flows are not anticipated and appropriate arrangements are not made in advance. Cash is the lifeline of a company, if it dries up so does your ability to fund operations, pay debts, reinvest and make payments.

What is the worst that can happen? Your business can go under, even with an annual turnover of a few million, or a turnover of a few hundred million. Businesses that are in danger look profitable on the surface, or on their annual reports, but are in an illiquid state. They do not have cash available for operations or emergencies due to funds being tied up in the cash conversion cycle (another scary financial term, which is explained further on).

Working capital is the cash your business requires to fund day to day operations, to turn raw goods or resources into products or services. Working capital is the difference between your current assets and your current liabilities. You want your working capital to increase, resulting in more cash flowing in, which can be used to run your business.

Signs you may be in working capital distress

  • Cash too low. Not enough cashflow to service operations?
  • High levels of Inventory. Are you tying up too much money on inventory and storage

costs?

  • High Trade Receivables (Does a lot of clients owe you money?). Your business is

not collecting cash for orders quickly enough, resulting in a shortage of cash.

  • Trade payables (do you owe a lot of money?). The aim is to lengthen the payable

days enough to be in your advantage, but not to cause bad faith with suppliers.

In practical terms this can happen if you sign a large contract on 60+ days payment terms, or pay a large deposit for goods ordered. In effect, you are spending money to deliver a service or product now for which you will only be paid at some point down the line, maybe even three to four months later. As a result, you are constantly in overdraft, and do not have capital available for organisational growth. The results in an unhealthy working capital cycle; your current liabilities are more than, or close to, your current assets, and your cash conversion cycle is too long.

How to Fix it

One way to tackle this problem is by shortening your cash conversion cycle; or the number of days from the time you pay out cash for raw materials until you receive cash for the finished goods sold. A cash conversion cycle consists of the following:

  • Inventory days/days inventory outstanding (DIO)is the deposit paid or the days that you own a product, room/venue booking, shuttle/service before selling it.
  • Accounts Receivable days/days sales outstanding (DSO)is the terms agreed with your clients as to how long you have to wait for payment.
  • Payable days/Days payable outstanding (DPO)are the supplier terms dictating how long you can wait to pay/what your credit terms are.

Let’s look at a simple example:

You buy a product from a supplier on 30 day credit (=30 DPO), it sits on your shelves for 20 days (=20 DIO) before you sell it, and then the purchaser takes 35 days (=35 DSO) to pay you.

Cash conversion cycle = DIO + DSO – DPO

Cash conversion cycle = 20 + 35 –30

Cash conversion cycle = 25 days

This means that it takes 25 days for you to convert cash to cash, during this period you will need to self-fund your business, this is also known as the self-funding gap.