Posted By Megacap | September 30, 2020 Photo Credit

Recently, a small business owner asked an interesting question on a Facebook page for people looking to learn everything about savings and business, especially the micro and small businesses. The question touched on the business conflict on pricing – higher margins that would translate to slow stock turnover, or lower margins that would translate to faster turnover. At face value, this sounds a lot like a pricing problem (that can be addressed partly by the article we did on pricing), while in actual fact it is a cash flow problem – as this is the ultimate consequence of whatever option any business chooses between the two approaches.

An interesting observation over the many years of engaging businesses with regard to planning is that more often than not many businesses struggle or even die not because of lack of profits, but because of largely ignored cash flow problems. The tragedy is, not many businesses are able to attribute these challenges directly to cash flow – and instead almost always attribute failure to low profitability. In essence, it is almost always a mix of factors at the heart of which is unrealistic cash flow projections in their financial models (overestimated income and underestimated expenses) and lack of anticipation of cash flow shortages and positioning for such eventualities.

To understand cash flow, it is important to first understand cash – that spending enabler that is money, quantified in various currencies and their denominations. In many cases, transfer of value through buying and selling involves money, or a form of representation of money. For an entity such as a business, this means getting paid for value the business gives to its customers.

Cash flow therefore refers to the movements of cash into and out of an entity in the course of its doing business (plausibly the difference between inflows – actual incoming cash and outflows – actual outgoing cash). Strictly speaking, inflows will include among others, revenues and injections (from investors, financiers and financial institutions, partners, development partners, governments etc.) Outflows includes all costs – operational, statutory, administrative etc.

The general rule of the thumb is that businesses should have more cash coming in than the cash they need to pay out within their money cycles – which in most cases is monthly for most companies (bills, salaries, rent etc. are paid monthly).

Why is it important for businesses to maintain healthy cash flows?

The single most important answer is to ensure they can meet their day to day obligations and still run operations smoothly within a certain period of time that would allow them space to make adjustments for survival should it be necessary. This means having the ability to meet obligations such as rent and utilities, salaries and wages, statutory payments, payments to suppliers for products and services obtained on credit, debt obligations etc. on time and without straining. This is one of the more important indicator of stability that provides a springboard for growth and sustainability. The opposite is also true – and cash flow challenges more often than not indicate danger signs for businesses which if not checked will risk ability to survive, a going concern in the medium to long term.

Causes of Cash Flow Challenges

Some of the more common causes of cash flow challenges include slower than projected inflows (such as sales / revenues / funding etc.) – especially in a scenario where a majority of the costs do not necessarily change proportionally to the inflows. This may stem from the already mentioned poor budgeting / projection (overestimated income and underestimated expenses), poor strategy execution by the entity or in some cases, unforeseen environmental factors such as the COVID 19 pandemic that forces a complete shift in the socio-economic set up that makes the business environment for the entity. Other causes include poor business models such as cash supplies, undefined credit sales (business buys products and services on cash basis but sells to customer on undefined credit terms), slower debt collection compared to payment cycles (the most common killer of small businesses in Kenya), higher costs of setting up (especially for start- ups and generally new businesses) and unchecked fast growth / expansion strategies that are debt or revenue driven (were massive debts or portion of revenues are used for expansion projects without keeping tabs on the implication on cash flows).

Way Forward

In this regard, it is therefore imperative for businesses to be proactive in managing cash flow if they are to avoid the perils that come from related challenges. The starting point ought to be prudent, realistic budgeting (and thus projections) with specific markers for cash flow and subsequent use of cash flow statements to track performance from time to time. This would become an important tool over time that can be used to establish a basis for critical cash flow management strategies and decisions over time as it would allow for operational cash flow projections over certain periods as may be relevant for the business. Businesses should also deploy effective strategies that will drive the desired sales/ revenues within said budget parameters. A culture of ‘no sale is complete unless the customer pays on terms’ would be key in accelerating debt collection, thus ensuring the majority of clients make due payments on time in line with credit terms. This will mean timely invoicing, effective follow-ups and most importantly, relationship management. Businesses may also pursue strategies to decelerate out flows – such as renegotiating credit terms with suppliers, restructuring financing obligations (business loans) and reducing unnecessary or avoidable expenses / payouts.

The writer is the Managing Director of Megacap Limited, a top tier consultancy company that offers customized consultancy on Strategy and Management for businesses and organizations enabling them to flourish.

Check out www.megacap.co.ke / Email: hello@megacap.co.ke