It is true that businesses that rely less on external debt are better placed to ride out economic downturns, but for many businesses external debt is crucial to sustaining growth. Undercapitalisation is a major threat facing small businesses throughout the world. So what are some practical ways in which you can manage and improve your cash flow?

Plan ahead

The best form of business planning uses three-way budgeting to look at profit, balance sheet and cash flow consequences. Understanding how your business decisions influence inventory, accounts receivable, accounts payable and cash flow is important; too often, businesses take a single view of decisions. The astute business person understands the three-way impact of their decisions.

Three-way forecasts will usually look at the next 12 months and are also useful in long-term planning, but what about the short term? A simple cash flow forecast can help manage your cash flow month by month. Build a template that records your regular receipts and payments. Schedule when loan and interest repayments, lease payments, utilities, rent, wages, supplier payments, planned capital outlay, income tax, and other outgoings fall in your business cycle. Then estimate your cash inflows. A good template will make short-term cash flow forecasting easier.

Communicate and enforce your credit terms

Have a credit policy and stick to it. Be diligent with credit checks before opening an account. Consider whether personal guarantees are necessary. Start customers with a low limit and extend it when they have proved they are worthy. If customers pay you outside your credit terms, be prepared to stop supplying them. Bad debts are costly and the lower your gross margin the more expensive they are.

Communicate your payment terms clearly to customers and print them on your invoices. Follow up customers quickly when they fall outside these terms. Try an automated email reminder a few days before an account is due. Ensure that debt collection is a formal responsibility of a staff person and monitor their performance.

To avoid customers using the cheque-in-the-mail excuse, print your bank account details on the invoice and encourage customers to pay electronically or by credit card. If you decide to stop supplying a customer, ensure you tell the sales team and the customer.

Monitor your position

Keeping an eye on your debtor days, creditor days and inventory days is a simple and objective way of managing your liquidity. Set a benchmark for how many average daily sales you are prepared to accept. Manage your inventory against a similar benchmark of average daily cost of sales. Creditors can also be measured by the number of average daily purchases. Why not plot your key performance indicators (KPIs) in a graph and share it around your organisation so everyone understands the importance of cash flow management?

Control your inventory

Stock is often one of the largest investments a business makes. However, stock can often exceed what is necessary. Tension can exist between the sales team and the accounting team about stock levels, so how can you manage this?

• Regularly reassess restocking points using realistic timelines for inventory and average monthly sales.
• Clear out slow-moving or obsolete stock and turn it into cash, even if it means making a loss.
• If you have good supply lines, consider whether you can arrange to ship direct to the customer so you do not need to carry stock at all.
• Consider whether you can hold consignment stock so you pay for inventory when you sell it.
• Buy early in the month so you maximise your time to pay.
• Set up KPIs for your purchasing team and monitor their performance against them.

Actively manage your cash flow

Use your short-term cash flow forecast to actively manage your cash flow. When you see a cash crisis emerging, keep your suppliers informed and offer partial payment of the amount due and negotiate extended payment arrangements. Consider offering settlement discounts to bring forward debtor collections. Keep the lines of communication open with your bankers. Ask for a temporary extension to your overdraft facility. Bankers don’t like surprises so ensure you work with them.

If your cash crisis is of a seasonal nature, or you experience a short-term slow down, consider sending your staff on annual leave. Paying staff their accrued leave is preferable to paying them to be idle.

Manage your capital assets and expenditure

In my experience, many cash flow crises stem from an inability of the business owner to contain personal expenditure. Protect your business by ensuring that your salary or drawings are not excessive.

Work with your accountant

Like anything in business, you can benefit from the experience of others. Your accountant will have experience of helping other businesses manage their cash flow. They can help you manage your cash flow by working with you to develop a three-way budgetand set up benchmarks and processes.