Congratulations! You have survived the downturn and your business, unlike so many others, is still alive and kicking. How do you make sure that, just when you have succeeded in surviving, you don’t snatch failure at this most dangerous of times – an economic upturn?

In ancient Greek mythology, Icarus succeeded in achieving the power of flight, but he flew too close to the sun and the wax that fixed his manufactured wings to his body melted. Icarus crashed into the Aegean Sea to his doom.

His achievement was also the source of his downfall.

Businesses run the same risk.

You have done wonders during the economic downturn and, at last, we are told that the UK is no longer in recession. Understandably, you might well feel the worst is over.

And yet, this is the time of greatest danger for your business.

Having lived and worked through times of bust and boom before, I have witnessed too many businesses do the hard part of surviving through the difficult times, only to fail just when times were getting easier.

How can this be? And how can you make sure your business does not become an Icarus business?
In this series of articles, I shall explain what you need to do to ensure that the prospects of impending success become real for your business, and not just for others. I don’t want your business crashing onto the sea!

You already know success requires hard work. In fact, it is hard work on the right things. Based on what successful businesses have done, let me explain what these right things are.

I start with CASH.

1. CASH – like blood, it must keep flowing

Your business is profitable and it has toughed out the downturn. Yet it is at risk of going to the wall.

How so?

It is because when business is picking up you are most at risk of running out of cash.

Let me illustrate this with a simple example.

Suppose you make widgets at a cost of £10 per widget and your price of the widgets is £12 per widget. A customer comes along and orders 30 widgets and agrees to pay you £12 for each one. It will cost you 30 x £10 = £300 to make all the widgets, but you will receive 30 x £12 = £360, and you are delighted to have made £60 profit.

Let us suppose that you incur the costs of making the widgets in January and you send the goods, with an invoice, to the customer. You reflect back on January as a good month when you made £60 profit.

However, now suppose your customer is very tardy in settling your invoice (a habit cultivated during the downturn) and does not pay you until April. From a profit perspective, it looks like your business made a profit of £60 in January. However, from a cashflow perspective, your business paid away £300 in January (to meet the bills that represent the costs of making the widgets, such as raw materials, wages etc); and your business received £360 in April. The cashflow perspective looks at when cash is actually paid away and actually received.

This is important. Suppose another customer places an order for 5 widgets in February. You need cash in February to pay the bills that represent the costs of making the 5 widgets – namely, £50. If your earlier customer had paid the £360 he owes you very promptly, you could have used some of that cash to pay the £50. But you do not have any of the £360 and so you do not have the £50 – unless you borrow it or can use cash that you have saved from past transactions.

However, there has been a tough economic downturn and you have no saved cash, your overdraft facility is fully drawn, and the bank is too risk averse to lend you anymore.

Now the economy is picking up, so yet another customer places an order with you – and another, and another. The cash from fulfilled orders is not coming in fast enough to meet the cost of satisfying outstanding orders. You have already borrowed up to your nostrils (the bank, suppliers, personal credit cards, friends and family) but you have become so accustomed to chasing sales during the downturn that you are loath to turn business away now when it is picking up.

So you run out of cash – and then, the VAT bill arrives.

A business that did the hard bit of surviving the recession, fails just when sales start to turn round and grow again.

Too many profitable businesses go to the wall during economic upturns because they run out of cash – and bills are paid with cash, not profits.

It does not have to be like this!

Cash, like blood, must keep flowing and a priority task for you is to forecast, monitor and manage your business’ cashflow. Inattention to the flow of cash can bring ruin, especially – and paradoxically – just when a recession is turning into an upturn.

So what does a cashflow forecast look like? It starts by listing every item of incoming cash and paid-away cash on a month-by-month basis, with the resultant net position being carried forward to the next month’s calculation.

Having listed all the appropriate items, the next step is to forecast the amounts involved and when, realistically, you expect to pay cash away, and when your business will receive it. In the example we have been discussing, you may wish that your customer paid you earlier than April; indeed, you may well be entitled to the cash before April, but if the fact remains that your best view is that you will actually not get paid until April, then it is in April when you should record the cash as arriving in your forecast spreadsheet.

By the same token, you might dearly wish to delay payment of an item, but if you cannot do this, then you have to record when, realistically, you expect to have to pay away the cash.

Experience will help you complete the forecast as can your advisors. You will then have a really useable view as to how cash flows in and out of your business. If there are likely to be any pinch-points, then these will become apparent and you can plan some remedial or preventative action in good time.

Remember also, that the cash you receive in a particular month may well be quite unrelated to the cash you pay away for, say raw materials in that same month. The cash income might well relate to a job of work involving raw materials that you paid cash away for several months ago. By the same token, the cash-outgoings on raw materials may well relate to a job of work, the cash-income for which your business may not receive for some months hence. This is one key point of difference between a cashflow forecast and a forecast profit and loss.

So, a cashflow forecast is an essential part of business planning illuminating how the business’ life-blood will flow month-by-month. Any need for a temporary blood transfusion – an injection of cash (such as by way of a bank overdraft) – can be foreseen and tee’d up in advance. Moreover, monitoring actual cashflow against forecast cashflow can highlight other important business issues sooner rather than later. For example, perhaps an expected cash inflow was less than forecast because a customer took longer to pay than anticipated. Was this a simple oversight or is it a sign that your customer is struggling financially? You need to investigate and, thanks to monitoring your business’ actual cashflow against the forecast cashflow that you so diligently prepared, you will be prompted to do so at an early stage.

Or perhaps you had an unexpectedly large cash outflow in a particular month. Was this the result of the new recruit in your business’ accounts department paying an invoice with more alacrity than is customary? Or perhaps a customer has placed a larger-than-expected order and your business’ operations team has ordered some extra raw materials as a result? Or perhaps a supplier has increased their prices?

By being alerted to the situation, you can investigate and take action – action which, although necessary, might have remained untaken without the benefit of the cashflow forecast and you using it. In the first case, a simple explanation of procedures to the new recruit and a modification to the induction training plan for the future might be all that is needed. In the second case, some customer tender loving care might be in order: some contact with the customer to thank them for the order and to understand whether this is a one-off or the start of a trend for which you would need to gear up your business accordingly. In the third example, you might decide it is time to shop around.

Remember: CASH IS THE LIFE-BLOOD OF THE BUSINESS!

ILLUSTRATION – It is often surprising what impact a few days off the working capital cycle can have

Let us consider the example of a business turning over £1 million annually with debtors taking an average of, say, 47 days to pay.

This means that no less than £128,767 of cash is tied up in amounts owed to the business. How much of that cash could the business get hold of?

[Calculated by (47 days ÷ 365) x £1 million = £128,767]

Well, if the business could get its customers to pay in, say, a not unreasonable 30 days, then this would claw back the princely sum of £46,575 for the business.

[Calculated by: (17 days ÷ 365) x £1 million = £46,575]

Let us suppose that the business is currently borrowing these sums on overdraft with their bank. If the business is paying, say, 5% then its interest cost on £46,575 for a year would be £2,329.

So, by bringing its average debtor period down from 47 days to 30 days, this business would increase its cash by £46,575. If it is currently borrowing this at 5%, then it would reduce its borrowing and save interest costs of £2,329 a year.

Room to share this saving with customers by offering inducements for prompt or early payment?

For each single day that this business improves its working capital cycle (eg getting paid a day earlier than currently), no less than £2,740 cash is retrieved at a borrowing cost at 5% pa of £137 pa.

Top Tips:

Prepare a 12-month cashflow forecast and update it every 3 months on a rolling basis

Monitor actual cashflows against forecasts every week – ask ‘why?’ – then always act

If you have an overdraft facility from a bank, never give them nasty surprises – always deal with problems with them in advance

Enforce payments terms and send invoices promptly

Manage stock levels more closely. You don’t have to jeopardise customer service: how much stock is ‘plus an extra 10% just in case’?

Email John Kirwan at: john.kirwan@augmentor-uk.com
Tel. 07818 054645