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29 Jun 2017

How to manage cash flow for business success


4 min

Cash is King!

While the concept that successful cash-flow management is directly related to business success is not new—and one you as advisors I’m sure are very familiar with—as insolvency practitioners, experience has shown us that inadequate cash flow or working capital is one of the biggest reasons businesses fail; and statistics support this.

ASIC’s reports of corporate insolvencies for the 2015-16 period reported that the top cause of failure in companies was “inadequate cash flow or high cash use”. In fact, this was reported in 45.6 percent of cases. When breaking this statistic down by industry, it shows that inadequate cash flow was most prominently the cause of failure in several sectors. Most notable were the following:

  • 54.9% of reports in the mining sector

  • 51.6% of reports in the accommodation and food services sector

  • 50.1% of reports in the retail trade sector.

Cash flow, defined as the total amount of money being transferred into and out of a business, is closely related to the concept of liquidity: the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price. The more liquid assets a company has, the better its ability to generate cash flow and to ensure it continues to trade solvently. Further, a liquidator considers a cash flow test to determine whether a company has traded insolvently.

So how do clients get themselves into an insolvent position? We’ve noticed a few key factors:

  • Working capital deficiencies are common. There isn’t enough money to begin with.

  • Many clients don’t understand that revenue is not profit.

  • Many businesses unnecessarily deplete working capital on non-essential items or assets that could be financed.

  • Excess levels of stock or obsolete stock exist in most businesses. As does excess or inefficient management and/or staff.

  • A failure to understand that different business types have different cash flow requirements. For example, developers, seasonal growers, and retailers have unique cash-flow ebbs and flows that must be managed.

To ensure effective cash-flow management, clients must understand their specific business’s cash-flow requirements and then plan and act to correct any deficiencies.

So, what should you as advisors consider to assist your clients in this process? Below is a list of questions or factors to consider that we’ve found to be most helpful:

  1. How can an advisor assist their client to improve cash flow, including monitoring, budgeting, and forecasting?

  2. Should an advisor change their mindset when discussing these issues with their clients? For example, it changes from just giving historical reporting or compliance based advice to financial planning and business advisory advice/information.

  3. What alternatives are available to clients who want to be proactive and seek assistance?

  4. Does the client properly appreciate their business and its risks and exposures to adequately budget and forecast their cash-flow requirements?

  5. Which assets are readily convertible to cash and which assets will take time to sell?

  6. Are there debt collection policies in place? Does the client conduct credit checks on its customers? Would implementing these procedures reduce the default rate?

  7. What would be the effect on a client’s cash flow if a discount for prompt payment was offered. For example, a 5 percent discount if paid in 7 days. Would this also reduce the default rate?

  8. Does the client plan for the effect that trade terms and write offs could have on their business?

  9. Does the business have its pricing strategy right?

  10. Does the client have balance sheet items that should be written off? Excess or obsolete stock levels, excess raw materials, superfluous plant and equipment or motor vehicles?

  11. Does the client’s purchasing policy need to be changed?

  12. Is sufficient working capital available to cover unexpected contingencies?

These questions, if considered well in advance, can minimise exposure to an insolvency event. If not, we examine these factors as administrators if we are attempting to save a business.

If you’d like to discuss managing and improving a client’s cash flow or alternative funding options, your local Worrells partner is happy to help.

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