How Cash Flow Can Cripple Your Business. Could You Be At Risk?


The key cash flow challenges impacting Australian SMEs

Money makes the world go round. It keeps the lights on, food on your table and heat in your home. Yet when it comes to your business, if you’re not getting paid on time, it can result in a massive strain on your resources, future growth strategy and your business valuation when it comes time to sell.

Good cash flow management is arguably one of the most important aspects in any business, no matter if it’s a start-up or a well-established enterprise. But if we look at the statistics, only 7% of businesses go on to become large businesses and at least 30% fail, all because of cash flow.

The Australian Small Business and Family Enterprise Ombudsman who reported on this trend pinpoints the divide that defines success as the flow - or lack thereof - of capital in your business to make that shift.

With the odds against them, most business owners need to learn how to effectively manage their cash flow so it isn’t causing growing pains. In this series of 3 articles, Exit Advisory will help Australian entrepreneurs develop an effective business strategy to manage their money, increase their likelihood of surviving, and actually build real value in their company.

Understanding the Cash Gap

Australian small businesses are being put in a difficult position because they aren’t getting paid fast enough. While the standard turnaround time is 30 days, this is often not met by larger businesses, which then has a trickle down effect for suppliers. One can’t pay until they themselves get paid.

And while late payments are actually down 7.3% year-on-year, it is still estimated that the cost of late payments equals $234.6 billion in lost revenue. That’s a 43% downturn in cash flow! There’s no wonder then, that small businesses are finding this cash block a major obstacle to growth. Whereas a larger company may have deep enough pockets to cover the shortage, for a small business they’d be sure to feel the squeeze. 

The Cash Gap in Practice

Let’s look at an example, say you are a manufacturing business, and you are ready to place an order for supplies and materials. You put in the order your production process kicks in. The stock you’ve purchased is on a 60 day term. However, you know that the time it takes to finalise production and get your product into your customer's hands will be 30 days. They’ll then have 60 days to pay you.

That means you have a Cash Gap of 30 days. It’s the interval between the date you pay out cash for inventory or wages and the date you receive payment from customers for this same inventory or service rendered.

In the midst of this, your company must still manage the ongoing commitments to pay employees, suppliers and bills. It’s a juggling act in itself, but when overlayed with late payments your business can quickly find itself in hot water.

After surveying over 600 SMEs, Prushka Fast Debt Recovery found that over half of Australian small businesses had outstanding debts totalling over $10,000 a month and Xero’s Small Business Insights report showed that just under half of SME’s (46.4%) failed to be cash flow positive.

The crux of it boils down to large businesses who set the pace for invoice settlements. More often than not, it leaves SMEs with heavy debts. In fact, the government initiated a Payment Times Reporting Framework late last year, which requires companies with over $100 million in annual turnover to publish information on how they pay small businesses.

While helpful, a better failsafe would be enforceable rules around payment times, including penalties for the estimated 88% of Australian Securities Exchange listed companies who do not pay on time.

Getting paid on time is the key to success

In an ideal world, your customers would be ready to pay you quickly and you’d be able to take that money to reinvest on expenses or other areas of your growth strategy.

The more a business can finance its growth with its own internally generated cash flow, the less it has to rely on outside capital. This means it’s easier to fund growth initiatives so you can scale the business. And, if you are thinking of selling your business, an acquirer will pay more for a company with less need of outside capital. But to achieve this, businesses must accumulate more cash by reducing collection times from customers and increasing payment times to suppliers.

Developing the right strategies so you can better your chances of success

No matter who your client is, how much they owe and how good of a relationship your business may have, to protect your assets, you need to crack down on late payments.

Later in the series, we’ll look into more detailed strategies for how your business can better overcome these challenges. But for now, let’s start with the basics. 

Cash Flow Doesn't Need to Cripple Your Business

Create an efficient invoicing system

A clear invoicing system is vital to maintaining a healthy cash flow, and the quicker you invoice, the faster you will be paid. No client will pay you before they’ve received an invoice, so you can mediate some risk by ensuring the seamless functionality of your housekeeping.

Have an updated risk assessment strategy

Secondly, assess your risks. If you’re continuously analysing who your slow payers or bad debts are, you can begin to create adaptive strategies aimed at minimising risk and improving the financial health of your business. This could include phone calls which could lead to collection letters and can continue upwards until more serious action is needed.

If you take the time to consider how your business can better manage its payments system, you could free up cash flow and reduce unnecessary stress.

If you are struggling right now, there are options like invoice factoring. There are providers that offer a 24 hour turnaround on invoice factoring, providing you with up to 80 per cent of the value of outstanding invoices when you need it. The remaining amount is paid to you when your client reconciles the account, minus a small service fee. This means you get your money quickly rather than waiting and putting strain on your company's day-to-day performance.

Risk assessment should extend to other key areas of your business too. Read about how they can impact company value.

Bank up your liquid assets

Having quick access to cash is vital for your growth and survival. According to the Australian Securities Investments Commission (ASIC), 60 percent of SMEs are forced to cease operating within the first three years. Out of that number, a whopping 41 per cent of business owners cited cash flow struggles as the primary cause of their business’ failure. 

Cash flow management is critical to every stage of your business journey

No matter where you are in the business journey the growth and success of your business is linked to your cash flow.

Having cash on hand to pay the bank, your bills, suppliers and payroll is one aspect, enabling you to effectively manage the day to day operation of the business.

However, as businesses grow the ability to monitor and forecast future cash flow allows you to manage critical stage gates of growth. For example, you may be considering opening a new location. Your cash flow forecast will help you predict the additional expenses and assess whether you can handle the upfront costs, you will also be able to overlay the additional revenue that you could generate from the new branch.

If the figures don’t stack up you could hold off and give yourself more time to prepare, or you may decide to expand in a different way. As companies grow they require staff increases, additional office space and will have increasing production costs. Your cash flow forecasts are essential to plan for these.

When you can forecast your company’s future financial position and model scenarios for growth your business will thrive. Managing your money well means you can use your cash flow to leverage additional borrowings and thus further growth. And if you are thinking of selling, you’ve made your business very attractive to a potential acquirer. They love predictability of income and potential for growth.

Whatever the case, your success at every stage will hinge on effective cash flow management.

Don’t be one of the 30% of SMEs that fail because of cash flow. We want small business owners to understand the importance of managing cash flow and how it relates to successful growth. 

Read our next articles in this series:

Planning to Sell Your Business? How Your Cash Flow Impacts Your Business Value

Feeling the Pinch? Six Cash Flow Strategies to Bridge the Financial Gap

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