FOR most small business owners, 2022 is looking better than 2021. The economy is reopening and people are looking to spend after being stuck at home for two years.
However, all is not rosy. Inflation haunts economies around the world. Supply chains are still strained. Interest rates are rising. There is a new administration coming and its plans for trade and the economy have yet to unfold.
“Turnover is vanity, profit is sane, money is king,” the saying goes. With customers demanding longer credit terms, suppliers trying to shorten theirs, and the cost of goods rising, managing cash flow is not easy. Added to this are the difficulties in obtaining financing from traditional providers such as banks and in financing the company’s structural changes. Nevertheless, there seems to be an opportunity for those who wish to find it. This is where cash management comes in.
A good cash management system leads to a better understanding of its customers and suppliers. This involves objectively looking at cash flows and making observations. Are my customers paying on time? Which of my suppliers allows payment extensions? Are there monthly or quarterly income patterns? From there, you can draw conclusions to support strategic decisions on how cash should be managed.
It also helps business owners understand the cost of growth. What is needed to sustain and grow the business is not free. This can help assess ways to lower the cost of capital by knowing which expenses can be dropped or minimized.
Finally, effective cash management promotes communication within the company. Employers know the frustration of miscommunication resulting in lost or lost money. Understanding the different moving parts versus cash flow will force various communication solutions.
What makes a good cash management system? First, categorize your cash flow. Cash management requires monitoring and controlling all cash flow in a business. Understand all cash inflows and outflows, then categorize them according to their nature, behavior and needs, starting with:
Frequency. Which cash flows are fixed, recurring or one-time?
Rising. What is the main source of income? Costs?
Deadline/urgency. What payments are due? Can these be extended? When is funding needed?
Consideration. What is the difference between paying employees and paying suppliers? With capital financing versus a bank loan?
After this exercise, you will already have a better understanding of your current cash flow situation.
Second, project your cash flow. Cash valuations that don’t have the future in mind are incomplete and will lead to bad decisions. After analyzing your current cash position, ask yourself how much money is coming in, going out, and when, then present them on a spreadsheet. You can start by making simple cash flow projections for the next 13 weeks and updating them weekly.
Don’t worry about missing projections. A good business owner will focus on understanding cash flow factors and adjusting assumptions next time. Also, these will always be less accurate as you project, so revisit them periodically and consider specific timelines based on certain business needs.
Third, create the necessary tools and processes. Once you have categorized and projected your cash flows, you can now decide what is needed to connect the different elements of your system. Let’s take the example of monthly rent payment and ask the following questions:
– What is required of this cash flow? By when is it due?
– How do you achieve this and what tools do you want to build? You need to know in advance, considering other expenses, whether you have enough money to pay on time. You should also know the method of payment (cash, bank transfer or check?) requested by the owner.
– Do you have the tools now? If so, are they effective/optimal and what can be improved? You often only realize a day before the payment that the rent will be due. If the funds are insufficient, then you rush to get them.
– If not, what should be done? You can set a reminder or alert system one week before the payment day to check if the funds are sufficient. If there is, the money can be allocated and set aside for the following week. If not, at least you know about it and have a week to come up with the money.
Knowing these cash flows in tandem with your projections will lay the foundation for a good cash management system for your business.
Ryan Jacob is currently the Senior Treasury Professional at First Circle. He is also a BAP-Ateneo Certified Treasury Professional.