Checking up on Cashflow

Checking up on Cashflow


Lack of cashflow is just as likely to crush a business as lack of profit. Too many business owners fail to differentiate between the two, or recognize that cashflow can make the difference to survival during difficult trading times.

A business can make a very healthy profit on paper but at the same time not have enough cash to pay liabilities.

Quite often business owners are interested only in the profit line of their accounts. If that looks healthy then they don’t want to spend time looking at other aspects of the accounts, they want to move on to other things they feel are more important.

By not looking at the trading figures more closely they can miss the fact there is a customer having difficulty paying their account, and that without the cash inflow from that debtor the company’s trading position is vulnerable.


Warning Signs

Cashflow warning signs include slow debtor payments with the 60 and 90 day unpaid amounts increasing month by month; increasing inventory (especially of slow-moving lines); and a sharp increase in borrowings. Often these aspects can be affected by carrying a high level of inventory or an inventory line that is not selling. It is also affected by slow paying debtors.

Take the example of a large debtor who might have been ordering a particular product from you several months ago, affecting your inventory re-ordering process, but who is increasingly behind in their account settlement. The business may automatically build up stock of that product to meet demand created, but the customer, unable to pay debts, has now switched to another supplier.

This leaves the business with an outstanding debt as well as an inventory that might be hard to shift – which, at this stage, is not reflected in the profit and loss account.

It is such scenarios that should encourage business owners to take the view that a profit is not a profit until the money is in the bank. Making a sale is only part of the equation. Getting paid for it is just as important and the money from sale should not be spent until it is in the bank.

As businesses grow, the demand on cashflow also increases. To generate growth, a business may be required to carry greater levels of trading stock or to increase the number of staff needed. These business inputs often must be paid for before the income that they will generate is received, causing a drain on the cash reserves of the business.


Increasing Costs

Managers who do not watch their cashflow are, at best, likely to increase the cost of doing business. At worst they will find themselves in a difficult trading position, affecting their survival.

Business owners should be careful of using only the profit figure to justify non-essential expenditure such as the lease of a luxury car, renting larger business premises, or replacing all the office furniture. Often such expenditure is a danger sign for a business, an indication that the business owner is losing focus. Increasing costs for rents, leases and the like put a strain on cashflow, often unnecessarily.

Business owners should make sure they get timely monthly reports showing changes in inventory, cash position, debtors and creditors, as well as other financial information that will help them better manage the business.


Some areas that a business owner should look at to help manage their cashflow include:

  • Maintain the focus on debtors. Remember that if customers are taking advantage of you by not paying their accounts, you are effectively funding their business while at the same time weakening your own financial position. Business owners frequently argue that they can’t afford to upset a customer by being too tough on credit control. Such an attitude is a big mistake. To begin with, customers who don’t pay promptly are probably not worth having. If you approach credit control in a businesslike way, customers are most likely to respect you than if they see you have an undisciplined approach. Consider also the use of other techniques such as factoring.


  • Control payments. A surprising number of businesses will have a policy of paying accounts within 30 days and stick to it regardless of the financial flows of their business. From time to time it may be a great advantage if you delayed payment to, say, 35 days when there are other cash demands on the business. The ideal is to collect receipts as soon as possible and hold off payments for as long as possible – but stick to your terms of trade as closely as you can. If you don’t, you can’t expect your customers to do so.


  • Inventory. Look upon inventory as capital. It has to be funded, and excess inventory is tying up business funds that could be used elsewhere. This doesn’t mean you should keep inventories at dangerously low levels causing you to lose orders because of your own out-of-stock position. However, it does mean that you avoid carrying excess stock that could end up becoming superseded or redundant


  • Control waste. Good expense control will help your cash position.


  • Cost of debt. The relatively low interest rates presently available, and the general low cost of funds, may have made business owners a little lax in their control of debt. Having an aim of keeping borrowings under control is a good discipline as it means that you are probably also keeping an eye on debtors to help your own cash position. It also means the increases in interest rates that are now widely predicted won’t be as damaging to your profitability.


  • Don’t spend what isn’t yours. Business owners often lull themselves into a false sense of security because they think their cash position is looking quite healthy, so they stop worrying about it. However, the reason for the strong cash position may be that in a couple of months a large tax payment is due. Make sure you know what your future liabilities are, particularly any unrecorded ones, so you are not spending cash you do not really have. Also, have funds on hand when deferred payments are due.


  • Employee entitlements. Similarly businesses may have a liability for employee entitlements such as long service leave, annual lave and superannuation. If business aren’t aware of these entitlements they may not be able to manage these responsibilities.


  • Growth expenditure. Impulsive or not properly planned expenditure on growth can also bring a company undone as this may not bring any returns for some time. So before making commitments in areas such as new plant and equipment or additional staff, review the cash effect. Will the income generated by the investment be greater than the actual investment? When will the income start to be collected? How will the business fund the cash outflows until the income begins?


Disclaimer : Information contained in this article represent general comments only and this is not advice. Tax is only one of the factors that should be taken into account when making a financial decision. You should discuss your tax affairs with a tax professional before entering into any financial transaction with tax implications.