Cash flow management
Robust and sustainable management of cash and working capital can increase stakeholders’ confidence in a business. Improving cash flow in order to reduce debt, fund growth or provide a better return to stakeholders is vital for any business, especially during periods of economic uncertainty.
Cash is the key to the survival, resilience and growth of your business. As the global economy continues to face challenges, effective cash management is becoming critical to maintaining a steady stream of working capital.
• Regardless of the industry you operate in, you can demystify cash management by taking proactive steps to gain control over the situation. These include:
— gaining visibility over cash flows
— managing working capital needs
— conducting thorough reviews to release illiquid cash
— ensuring the business model fully considers cash requirements.
• A thorough understanding of a business’s cash position is essential in terms of allowing visibility and control in the challenging environment and times we face.
An efficient working capital position can help you release cash to fund additional growth initiatives. Extracting cash from working capital requires an extensive review of the business at a granular level – one that looks beyond the simple statistics such as days payable outstanding, days sales outstanding or inventory days and digs deeper into key functions across payables, receivables and inventory.
• For example, consider a scenario where your business has negotiated an advantageous price for certain goods but has entered into a contract that requires payments every fifteen days instead of thirty. A liquidity assessment may reveal that the amount of cash tied up in working capital as a result of that payment schedule is negatively affecting the business in the long run. A meaningful investigation of working capital would reveal opportunities to create (or protect) portfolio value.
If you want to improve your working capital cycle and cash flow, you should aim to:
— Develop robust cash flow forecasting processes and controls.
• You should rely on your short-term cash forecast to underpin resilience strategies and determine response priorities as well as to engage with creditors and funders to seek forbearance and support.
— Analyse immediate and near-term funding requirements.
• You should be focused on establishing and improving visibility into the sources and uses of cash. Management and owners must quickly determine whether their businesses have adequate visibility into their cash positions, determine their cash needs and address any shortfalls.
— Stabilise cash flow and buy time for negotiation with stakeholders.
— Identify cash generation opportunities.
— Review working capital cycles and make recommendations to reduce the working capital requirements of the business.
— Drive improvements in debt collection.
• The key aspect of your cash management should be getting the money you are owed within the agreed time periods.
• Establish consistent collection terms with customers and collect cash at the point of order on single orders.
— Prioritise cash outflows: determine which payments are more important and urgent.
— Promote and embed a cash culture within your business.
Establish a cash-focused culture that values cash over profit. Put in place sound and clear governance for challenging environments that allows effective management of liquidity.
• Put cash at the heart of operational and strategic decisions. If customer demand is low, your business should seek to reduce inventory levels and postpone operational or capital expenditures that are not critical to near-term continuity. Postpone or eliminate discretionary spending across the business.
• The mark of a well-run business is a cash culture based on effective working capital management. Unlocking cash is always cheaper than borrowing and less disruptive than selling assets. This cash can be used to fund new growth, retire debt, gain price discounts on cash purchases, benefit from a top commercial credit rating and take advantage of market opportunities.
• Working capital management aims to maximise cash flow through the complete transaction lifecycle from forecast to cash settlement. This process is particularly relevant to business with sizeable accounts receivables, accounts payables and inventories. Other contributing factors include significant capital expenditures, real estate, and fixed asset holdings.
• Businesses must have full awareness of the profitability versus liquidity trade-off. You can be a profitable business but have cash problems. Having a lot of cash and other liquid assets (those that are easily sold) will contribute to the liquidity of the business and ensure that maturing liabilities can be paid when they fall due. On the other hand, having a lot of liquid assets will reduce the profitability of the business as cash is considered to be an idle asset that will not generate extra inflows.
• Employing an 20/80 rule will be helpful. This means that 20% of inputs provide 80% of outputs: businesses should focus on the biggest consumers of cash rather than micromanaging small costs whose overall impact on cash flow is minimal.
Illustrative example of profitability analysis
A retailer sells a product through two different channels: a physical store and an online web site. The web site was opened only recently so most of the operating efforts were still directed at the physical location. The retailer noticed a significantly higher number of sales online than instore.
The retailer heard about the ‘20/80 rule’ (in economic theory, the Pareto principles) meaning that 20% of the inputs should generate 80% of the outputs. The retailer found that one input (out of 20) was consuming 50% of the business’s effort but only generating marginal profits (below 10% of all profits). Therefore the inputs (supplies, labour hours, operating costs and so on) for these profits were significantly reduced and redirected to other more profitable sales channels.
Despite the improvements, the 20/80 rule was not immediately reached. After the initial change, the ratio was around 30/70 but the retailer was now aware of the metric which helped it keep track of selecting the right inputs and products to achieve more profitable business outcomes.
Managing liquidity in times of crisis
Turbulent and challenging periods of operation reinforce the importance of cash and call for changes of the liquidity management framework. Challenging environments are making businesses focus on effectively managing cash as they may face liquidity shortfall (temporary cash flow problems). Good liquidity management will help your business to be more resilient if it faces economic downturn.
• Many businesses deal with cash flow disruption and difficulties such as paying salaries, stress on collections and suppliers going bust due to liquidity crunches.
• In a liquidity crisis, the cash consequences should be considered in respect of all operating decisions – running out of cash (including available facilities) is the only true way to become insolvent.
During liquidity challenges, businesses should look into new cash sources, such as government relief or new credit lines.
Conduct a detailed analysis of current and future working capital and cash flow requirements.
• Review forward orders to determine whether there are any credit risks due to customers increasing or cancelling orders, or any actions that have to be taken.
• Look into your supply chain. Try to estimate your supply and demand and plan your inventory accordingly. You need to be aware of market trends so as not to order too much or too little inventory.
• Re-evaluate your customers based on their payment histories and their expected cash flows. You should also consider credit checks and setting limits for new or existing customers you believe will have difficulties in paying for your goods or services.
Use short‑term cash forecasts to underpin resilience strategies and determine response priorities. A key element of cash crisis management is the preparation of a survival cash flow forecast with key actions identified and a governance structure established in order to achieve the required actions.
• Reconcile the short-term cash flow with monthly financial forecasts including P&L, the balance sheet and funds flow.
• Test a wide range of sensitivity scenarios against your base forecasts to model cash burn rates, cash reserves and facility headroom. These should include realistic and possible risk scenarios, such as an extension of the current crisis, as well as customer- or supplier-specific events or disruptions.
Businesses in immediate cash crisis should take steps to preserve cash balances by restricting payments to only the most business-critical vendors while they mobilise contingency plans.
• In such times, it is necessary to cut costs and rationalise operations to preserve cash. This could include reducing miscellaneous spending or reducing employee costs via flexible working conditions such as part-time work and furlough or lease costs to preserve cash. Draw down all existing funding lines to maximise the available cash.
• Revisit the full range of internal and external options to support liquidity on a regular basis and identify rapid, achievable ways to reduce costs. Create a mechanism to closely monitor changes to government policy that may have an influence.
• Brainstorm a self-help plan (this is considered a contingency plan) to preserve and generate cash, as well as initiate actions in conjunction with all key functions.
• Defer all capital expenditures and projects.
• Consider a budget recast. Update your budgets or forecasts created before the crisis occurred to recast them using information from the current situation. Recasting refers to adjusting items within the budget that are no longer relevant to the business.
• Apply the principles of zero-based budgeting to reduce costs. Zero-based budgeting is the practice of setting every budget item to zero in every department for every account and then requiring that every budget item has to be justified.
Enhance reporting and analytics to ensure you have an immediate view on the current liquidity position. As a first step, you can utilise simple reporting tools and analytics such as simple tables summarising key elements in Excel or Word.
Prepare detailed lists of countermeasures that are immediately available during challenging periods. Detail the countermeasures in terms of their liquidity impact, implementation time, costs, market signalling and franchise implications for a number of generic scenarios.
• Some of those measures may include:
— discussion of deferred payment options with your suppliers (identify non-critical suppliers who could be paid more slowly), government bodies, and others
— getting in touch with your customers for collection of receivables or charging interest on overdue debt where practical
— increasing the frequency of invoicing where terms are from the point of invoice
— eliminating the practice of allowing a ‘cooling off period’ from invoices if local law allows this
— identifying variable and semi-variable cost elements in your cost structure to determine where you have room for cost cutting.
Should you find your business facing immediate cash flow issues resulting from an external economic shock, following a clear, concise plan can help you manage your way through the crisis. Use the cash and working capital checklist to help navigate your way through those turbulent times.
Prepare for future crisis
Businesses must act with imperative when developing and implementing enhanced risk management practices, focusing on the opportunities contingency planning offers in creating pre-emptive action plans.
• Scenario planning is the process of forecasting the base (forecasted or expected), best case and worst case scenarios for your business. It enables businesses to see the bigger picture and make effective trade-off decisions on issues including how much inventory to hold and where, or how to balance the cost of inventory versus the cost of failing to satisfy customers. Simulations can be run swiftly to identify sweet spots between apparently conflicting objectives, based on real-time inventory data, customer demand and supplier capability.
• By analysing past events and hypothesising future threats, businesses are able to identify strategic and concentrated supplies that are at risk in major crises and, most importantly, recognise when current internal risk capacities prove insufficient.
• Create an emergency fund that will help you remain liquid for a certain time until you can decide how to cope in any unfavourable situation.
• A fallback budget helps you prepare for future economic downturn or other challenging times. The plan will provide clear guidance and help you cut down on things that are not essential for your business and thus reduce your expenses.
• A business continuity plan will also help you continue your business operations in times of disruption. It helps you revive your business operations when incidents occur. It increases resilience and your chance of survival following disruption.