In our previous article, “Why do small businesses fail,” we found out that the majority of businesses fail with the first 24 months of being set up. Research also shows that between 70% and 80% of small businesses fail within the first 5 years. Of the businesses that fail, about 82% fail due to poor management or understanding of cash flow. So, what is cash flow management so critical for a business?
Why do businesses need cash flow management?
A good cash flow management tool is essential because it:
- Is great for planning your business activities
- Enables resource allocation
- Ensures that business activities are correctly aligned with each other
- Supports businesses in making sensible, realistic decisions for the business
- Gives business owners greater control over their business finances
- Allows businesses to better understand their business performance
- Helps businesses plan for the future
- Helps business secure funding
- Helps identify and indicate where the business may go into the red and therefore need a cash injection
- Helps identify and show where businesses may have excess cash and therefore help identify opportunities to invest this extra cash
- Identify debtors that have fallen behind so that, if needed, you can chase these for payment
- Identify creditors whose payments have fallen behind. You can then use this information to negotiate repayment terms, or payment arrangements so that you can maintain good working relationships with your creditors
- Identify where you will have excess cash and therefore decide on what to do with it or if you may re-plug this into the business in order to grow it
- Identify where funding may be needed and begin planning for this and where to get it. Potential funders may want to see your cash flow past and future, before approving the much-needed capital injection.
- By doing sensitivity analysis, setting a few “what ifs,” businesses are able to plan and make important decisions about the future of the business.
It all starts with accurate and proper record keeping:
Financial records should be updated more regularly. With cloud accounting technology, financial information and records can be updated in real-time. Keeping accurate and up-to-date financial records is key for the following reasons:
- It will give the business owners a clear and better understanding of their business performance
- There is a reduced tax risk when dealing with SARS. Where inaccurate or incomplete records are kept, estimation of taxes can be a challenge for the business owners and optimising tax will be a near-impossible mission. This can result in the business incurring unnecessarily high tax bills, which could be avoided if accurate and complete records where kept.
- Some funders now require access to business’ real-time financial data in order to complete the funding process. Most investors and funders will simply not invest in a business without complete and accurate financial information.
- Having accurate and complete financial records will simplify the cash flow management and focusing process.
Revenue growth vs. profit growth:
In our previous article, “is your business overtrading…” we indicated the dangers of pushing for revenue, not profit (or not finding a balance.) We also find that businesses that focus mostly on revenue, not profit, tend to struggle in the long-term. On the other hand, businesses that focus on people and profit tend to perform well over time.
Most small business owners confuse revenue growth with profit. As a result, a lot of time is spent in the meeting with the “accountant” discussing the question, “We have made lots of sales, where has all the money gone to?” To simplify this, revenue is all the sales the business made while profit is those sales less all the costs the business has incurred (excluding money spent to buy capital assets.) So, it is possible for a business to have tones of sales and no profit or very few sales, but have a profit. It all comes down to how well your business manages costs and cash flow.
As a practical example, one business owner we know (not our client) was in the construction industry and doing very well. He took out over R4 million Rands from the business to build himself a home. Just as he completed his home, new orders started coming in, but he longer had money in the business to service these contracts. This is the mistake most small businesses make, poor capital allocation. When the business is doing well, they tend to take everything out in the form of salaries or dividends without careful consideration being given to where this money can be allocated to grow the business (new markets, or new products.)
“For to everyone who has will more be given, and he will have abundance; but from him who has not, even what he has will be taken away.” Cash flow management is not a complex process, it just has to be taken seriously and put before everything else.