Good Cash Control – A Non-Negotiable for Business

COVID-19 has presented a significant challenge to our health system and our economy and, in response, the Federal Governments of both Australia and New Zealand have implemented unprecedented support measures to assist businesses.

However, with these measures starting to be wound back over the second half of 2020, businesses will be left to manage a subdued and uncertain business environment. Many, otherwise viable, businesses could face financial distress, and some are likely to fail. In this environment, good cash control and effective cash flow management is increasingly important to a business’ sustainability.

In uncertain times, it’s common for business owners to focus on things other than cash flow such as sales, expenditure and profitability. They only pay attention to cash flow when something goes wrong.

The fact is, all businesses leak cash. Some from poor decision making or weak processes and some from fraud. During periods of uncertainty, the pressures on business processes and the incidence of fraud increase cash leakage, and this is particularly the case for small businesses.

To prepare for what is likely to be a prolonged recovery period from COVID-19, it is critical for businesses to understand their cash flow management and the effectiveness of their cash control. Here are some of the key areas businesses should be across.

Good Cash Controls

Good internal controls are important to minimise cash leakage and reduce the risk of fraud.

Cash management is the process of collecting and managing cash flows. It is a key component of a company’s financial stability. Cash is the primary asset companies use to pay their obligations on a regular basis. In business, companies have a multitude of cash inflows and outflows that must be carefully managed to meet payment obligations as they fall due, plan for future payments and maintain adequate business stability.

Given the importance of cash flow management in times like these, businesses should look to develop a plan for cash management as part of their business risk and continuity plans. Often businesses look to cut staff, delay paying suppliers or reduce dividends to generate cash, however these measures can have negative consequences for stakeholders and are not always sustainable. To maximise cash, business should understand all the triggers that impact cash flows in addition to the traditional working capital measures.

Cash Flow Forecasting

A cash flow forecast comprehensively projects a business’ cash flow and its future cash position. It includes:

• Projected cash inflows from accounts receivable.
• Cash outflows for accounts payable.
• Cash outflows for investing.
• Cash outflows for financing.

A cash flow forecast should report how much cash a company has readily available. Cash flow forecasting is often done on a monthly or quarterly basis, however during times such as these, businesses are turning to forecasting cash on a weekly or even daily basis.

Ratio Analysis

In addition to forecasting cash flow, good internal controls include regular monitoring and analysis of liquidity and solvency ratios within cash management. External stakeholders, including key customers and financiers are particularly interested in such ratios.

The two main liquidity ratios analysed in conjunction with cash management include the quick ratio and the current ratio. Solvency ratios look at a company’s ability to manage all its payables, both short-term and long-term. Some of the most popular solvency ratios include:

• Debt to equity.
• Debt to assets.
• Cash flow to debt.
• Interest coverage ratio.

Working Capital Management

A primary reason for small business failure is a lack of funding or working capital. In most instances a business owner is intimately aware of how much money is needed to keep operations running on a day-to-day basis, including:

• Funding payroll.
• Paying fixed and varied overhead expenses, such as rent and utilities.
• Ensuring vendors are paid on time.

However, owners of failing companies are less in tune with how much revenue is generated by sales of products or services. This disconnect leads to funding shortfalls that can quickly put a business out of operation.

Sure-up your own financing

Business owners often look externally to banks, finance companies and other lenders to increase their access to additional cash. However, they may often overlook internal sources to increase cash flow – by freeing up working capital on the balance sheet of their business.

Variable and discretionary Costs

It is important to minimise discretionary spending and possibly try to convert fixed costs to variable costs.

Improve your cash to cash conversion cycle

There are several things you can do to improve both receivables and payables efficiency, ultimately leading to higher working capital and better operating cash flow.

You can reduce the days payable or offer discounts to your customers for quick payments. They may also choose to use technologies that facilitate faster and easier payments such as automated billing and electronic payments.

Advanced technology for payables management can also be helpful. Companies may choose to make automated bill payments or use direct payroll deposits to help improve payables cost efficiency.

Revisit your capital investment plans

Consider deferring capital investment or consider leasing or equipment hire options rather than payment in cash.

However, when considering this, businesses need to understand the risks associated with not pursuing investments where those investments might be critical to sustaining or growing future cash flow.

Inventory Management

Inventory can soak up cash. It is important for businesses to monitor order points and minimise order sizes whilst they focus on increasing inventory turnover. Well run businesses will understand and manage inventory turnover on a unit by unit basis.

If you would like assistance in understanding the effectiveness your cash controls and what actions you could take to improve cash flow and minimise leakage, contact the Visory Team. We have experienced staff throughout Australia and New Zealand who can help and guide you.