Cash Flow Improvement

Written by Drew Coles, member of the chartered institute of Management Accountants.

Having sufficient amounts of cash is vital for all businesses. Many profitable businesses fail due to lack of cash. Cash is needed to fund the working capital cycle which includes stock, materials and tooling for instance. It is therefore extremely important for organisations to control and manage the cash flow in and out of the organisation to ensure there is sufficient liquidity.

Graph showing Working capital cycle from cash to sales

Methods to improve cashflow

Reduce working capital

Working capital funds can be substantial to enable the smooth running of the company. It may be possible to reduce the money tied up in material stock, WIP and tooling to release cash into the business bank account using such methods as Just in time stock levels. This will need to be balanced appropriately so the stock levels do not fall too low as to jeopardise customer order fulfilment.

Restructure customer and supplier payment terms

By restructuring customer and supplier accounts we can improve the business bank balance. It may be possible to renegotiate payment terms with customers to shorten credit terms. Other ways to ensure customer receipts are received are to set up customers on standing orders and direct debits. The above can be combined with a renegotiating of supplier credit terms to lengthen the payment period. If this is not possible the company should ensure they extend the payment credit as long as possible into the payment terms.
Other considerations are to offer a discount to customers to encourage earlier payment. However the cost of this discount must be taken into account.

Cash flow forecast spreadsheet illustration

Forecast your cash flow

It is important to forecast your cash frequently. This should be at least monthly to ensure cash balances are accurate and positive. If the bank balance is low forecasting should be changed to at least every fortnight. This is to ensure if the balance does go into negative figures a plan can be put into action to deal with the period of cash shortfall.

Bank facilities

Bank facilities such as a bank overdraft can be of great use in times of a cash shortfall. Making use of a bank overdraft facility will also provide flexibility in order fund working capital for example. These types of arrangements will only be forwarded to companies in a good credit position with good credit scores and proof that repayment will be forthcoming. There is also a cost for the use of these types of arrangements which should be considered.

Invoice discounting and factoring

Invoice discounting or factoring are an option to improve business cashflow. These types of companies offer agreements where by a percentage of the invoice amount is paid in advance to you and they have the responsibility to collect the debt from the customer. Once the debt is collected they will pay the rest of the invoice into the business bank account minus a fee. Non-recourse and recourse factoring are two options with non-recourse being preferred as they cannot claim back bad debts from your company. One factor to take into consideration when using these options is that these companies will have direct communication with your customers meaning that the way they communicate will have influence your business image.

Ratios to check your liquidity

There are several ratios which can help the business understand its liquidity position. This is beneficial in terms of receiving debt finance as these ratios will be checked by lenders before deciding to advance your business funds.
Firstly, the current ratio and acid test ratios are important these check the number of current liabilities to current assets. There is averages for each industry type but usually a current ratio of 1:1 is sufficient for business. That is there is 1 current asset to every 1 current liability owing. Other ratios which can be used include Payable days and receivable days these ratios provide the average number of days taken to pay suppliers and receive payments from customers. These should be assessed against your target collection and payment schedule.