The oft-repeated mantra for many business advisors and accountants these days to businesses affected by COVID-19 is ‘Manage your cashflow’. Which is good advice really – but how does one go about making sure that your cashflow is managed properly? Today I will discuss 3 key actions you can do to get on top of your cashflow during these trying times.
Before we get started, it is important that you understand that Cash is not the Same as profit. Read this article I wrote about cashflow first before reading the rest of this article.
Have you read it?
Are you sure?
Ok, let’s get started then.
No. 1: Keep track of your daily cash expenses and make a cash budget
On most normal days, a good accountant will tell you to keep track of your monthly cash expenditures. I make it a point to review my personal cash position at the end of every month. It is good practice and it helps you have a better understanding of what activities bring in cash for you and what activities do you spend a lot of cash on.
However, given that we are facing a crisis like no other (not exaggerating here) it becomes especially important that we monitor our daily cash usage. How can we best monitor it? Very simple – login onto your internet banking portal, and look at your most recent transactions from your business accounts. Take note of any money coming in and of any money going out. Online bank statements are super easy to read these days and you will be able to pick these out easily. Once you have identified them, simply pop them into an excel (or air tables if you’re boss) table with the following simple format:
If you are using accounting software like Xero, this process is simplified through the cashflow report generator (since it syncs up with your bank feeds), which gives you a snap shot of daily, weekly and monthly cashflow. message me on my FB (be sure to like it!) if you want to know how to do this.
Most days you will have more cash out than cash in, but that’s ok. As long as you are making enough cash in to cover the cash out you are sweet. Keep an eye on that bank account balance!
The great thing about keeping an eye on your cash expenses is that you can budget and plan ahead for your cash expenditure in the future. Yay for financial forecasting!
No. 2: Manage your working capital
What is working capital? These days everyone and their accountant’s uncle seem to be talking about working capital.
Working capital is the money you require to ensure your business remains operational during the working capital cycle.
What is the working capital cycle?
The working capital cycle is the amount of time it takes for you to convert inventory (stock) to sales (irrelevant if you are a service organisation), convert accounts receivables into cash and pay your suppliers. Simply put, it is the amount of time it takes to convert inventory into cold, hard cash. At the end of the working capital cycle, you would have new cash in your cash reserve which should hopefully give you enough to cover your next working capital cycle.
The basic formula is given as:
Working capital cycle = Average days taken to sell inventory + Average days taken to collect debt – Average days taken to pay suppliers
For example:
Jimmy runs a garden supply shop. On average it takes him 10 days to sell inventory from the time he brings it into store. He gives his customers credit terms of up to 30 days, but on average he gets paid within 40 days because some lousy buggers take their own sweet time on paying up. Jimmy is a good man and pays his suppliers on average within 15 days. How long is his working capital cycle?
Answer: 10 + 40 – 15 = 35 days
This means that Jimmy needs to have enough cash reserves to cover operating costs for 35 days. Operating costs include anything and everything relating to the running of the business – utilities, wages, rent, marketing, advertising, etc. This cash used during those 35 days is known as working capital. If Jimmy’s business does not have enough cash, then Jimmy needs to hustle up some munnayh, either through introducing his own funds into the business, getting equity investment or using bank credit through credit cards or overdraft facilities (the most common option).
What does this mean for you?
This means that you need to work out what the working capital cycle is for your business and use the handy-dandy cash budgets you developed above to work out how much money you will need to cover business operations for the foreseeable future.
Let’s have another example:
Jimmy has figured out he has a working capital cycle of 35 days on average. He’s done a handy-dandy cash budget and he knows that he needs about $10,000 to cover the business costs for those 35 days. He has about $5,000 in cash reserves right now, so he needs to borrow an additional $5,000 to cover his operating costs for the next 35 days.
But oh, no! It’s the COVID-19 recession! No one is buying anything anymore!!! *screams*. Ok, that was an exaggeration. But yes, the recession has caused buying sentiment to drop and Jimmy can expect some customers to pay later and some to simply stop buying. In which case, Jimmy can be conservative and double (or triple depending on how bad the situation is) the working capital cycle and borrow the amount required to finance that duration.
For example:
Jimmy realises that business is going to be pretty crap due to the COVID-19 recession, so he makes a conservative estimate of 2 times working capital cycle which is 70 days. He needs $20,000 to cover his operating costs during these 70 days and approaches the banks for an overdraft facility.
Now, at this stage, the savvy reader (that’s you! You savvy person you!) would have realised that you can tweak the working capital cycle by collecting your debts faster,
reducing the time it takes to sell stock and paying your suppliers later. Which all means that your working capital requirement is a lot lower. If you somehow wind up with a negative cash number, all that means is that you have an effective working capital cycle of 0 days.
0 days? Does that mean I don’t need to borrow money to fund my business?
Er, not exactly – you still have costs to pay to operate your business and if you predict that income will drop like a brick during the COVID-19 crisis, you should still borrow enough to cover any predicted cash shortfall for the next several months or so (assuming you don’t have enough cash reserves in bank). Which is exactly what that cash budget is there for – to calculate how much cash you need to keep your business running if your income drops (or disappears)!
No. 3: Communicate, communicate, communicate
Handy-dandy cash budgets and working capital wizardry aside, the most important thing you need to do to manage your cashflow is to communicate.
All that cash you are spending goes somewhere right? And more often than not, it goes into the pockets of individuals you can talk to. Individuals like your team members, suppliers, contractors and the bank. All that cash you are getting also comes from somewhere right? I’ll bet my website ownership that it is coming from the pockets of your customers!
So you need to talk with these people. Negotiate better terms with your suppliers. Talk to your team members about revising their work hours/rates (talk to them about the NZ wage subsidy if you are NZ based). Talk to the bank about what sort of credit options are available for you. Talk to your customers about paying off their debts to you or negotiate cash-based sales.
Communication might sound simple on paper, but it is the most difficult of the three steps to manage your cashflow. It arguably is the most important as well. No amount of budgeting and planning will help you if the key stakeholders in your business (that’s everyone mentioned in the previous paragraph) don’t want to play nice with you.
Chances are that they are as badly affected by the COVID-19 financial crisis as you are so they might be more sympathetic to your concerns. But that being said, you need to be sympathetic with their concerns as well. At times like these, it is important to be transparent. Be clear with your stakeholders what your exact financial situation is. Share your cash budget and working capital calculations with them (this is especially true with team members). Ask them what their needs and expectations are during these trying times. Ultimately, you want to work together with your stakeholders to achieve a Win-Win situation for everyone.
That’s all for today. Hopefully there are some clear, actionable items in this article you can get cracking on.
Stay safe and stay calm everyone. We’ll get through this together!