Understand and manage your cash flow needs so that they are no longer a problem
As every company knows only too well, cash flow is of the utmost importance: it guarantees the company's ability not only to meet its financial obligations, but also to invest in its own development. It's best to take good care of it!
However, despite healthy sales, cash can sometimes run out... sometimes dangerously so 😰. In such cases, it's important to understand what factors give rise to such a phenomenon in order to better anticipate, but also to know how to finance an urgent cash requirement should the need arise.
There are many possibilities and solutions available to you. We take stock in this article co-authored with Eric Desquatrevaux, Managing Partner and founder of Avizo.
Cash flow requirements: definition
The need for cash defines the situation in which a company no longer has sufficient liquidity to cover its various expenses, in particular :
- payment of salaries ;
- payment of suppliers ;
- ongoing expenses such as rental or maintenance costs for premises.
💡 This concept is similar to that of Working Capital Requirement (WCR), referring to current cash flow shifts due to the operating cycle.
Most organizations, even those whose business is running smoothly, are confronted with this cash requirement. Particularly when it results from structural factors; we'll tell you all about it next.
Factors in a company's need for cash
Structural factors
👉 Here, we're talking about factors relating to the intrinsic characteristics of a company's business, and which regularly affect its cash flow.
Long customer payment terms
Most organizations, especially those operating in BtoB, grant their customers fairly long payment terms, sometimes amounting to up to 60 days.
😬 The problem is that they have already incurred costs to:
- supply the product or service to the customer ;
- run their business properly in general.
And that creates an obvious cash flow gap.
Short supplier payment terms
Staying with the theme of payment terms, if your suppliers are too short, you find yourself having to disburse funds faster than you generate revenue.
Too much stock
Excessive stock levels are also a factor in cash requirements, since you have to pay for them before you can sell them to make up the difference. In other words, it ties up funds without generating immediate income, thus limiting the availability of cash needed to run the business.
☝️ Hence the importance of following a well-honed inventory management process, to avoid over-stocking while ensuring product availability to customers.
Investment
Investment (purchase of fixed assets, financing of development projects, etc.) can generate a structural need for cash.
Indeed, the operation requires substantial short-term cash outflows... with the aim of stimulating long-term growth and profitability. But there is a time lag before it actually generates profits ⏳.
Seasonality
Finally, seasonality often leads to significant fluctuations in cash flow.
👉 For example, a ski resort experiences peaks in activity and income during the winter months, but faces slower periods during the summer.
This variation leads to temporary imbalances between cash inflows and outflows, requiring careful management to ensure financial stability throughout the year.
Cyclical factors
👉 Sometimes, the need for cash rises sharply above what is commonly accepted. Various factors are involved, some of which are difficult to anticipate, and some of which are more damaging.
In all cases, managing your cash flow correctly will greatly limit the consequences of both structural and cyclical factors.
Sudden growth
Sudden growth, and therefore the need to meet rising demand, considerably increases cash requirements:
- various investments (in equipment, software, premises, etc.) ;
- hiring additional staff ;
- increasing inventories.
All of this leads to a substantial cash outflow in the short term, before the company can generate enough revenue to break even.
Late customer payments
Here, we're no longer talking about the agreed payment deadlines mentioned above.
We're talking here about real late payments, with customers who break the rules... putting you in the red, as the phenomenon of timing differences described above becomes more pronounced!
☝️ Not to mention the fact that if the situation escalates, you'll probably have to embark on costly legal proceedings, which will further destabilize your finances.
External events
Finally, when we talk about factors that are difficult to anticipate, we inevitably think of external events such as natural disasters or conflicts.
Interruptions in the supply chain, reduced demand, affected customers who can no longer pay or cancel their orders... these are just some of the potential consequences that could affect your cash flow.
A word from the Expert
To avoid the consequences of economic factors having too great an impact on cash flow, solutions can be envisaged to better prepare for these unforeseen events.
In fact, cash management also involves building up a cash reserveor taking out insurance to cover certain risks .
The aim of this strategy is above all to absorb financial shocks without compromising current operations, and to protect against specific events that could have a significant impact on cash flow, by taking out appropriate insurance cover.
How do you calculate your cash flow requirements?
To be able to act as quickly as possible in the event of a problem, it's best to anticipate your cash requirements!
And there's no better way to do this than with cash flow forecasts. Presented in table form, they enable you to forecast cash flows over a defined period, usually monthly or quarterly.
👉 Here are the steps to follow to produce them:
- List all potential cash inflows over the period under review (sales, loans, investments, etc.). Be as exhaustive as possible.
- Do the same for disbursements (payments to suppliers, salaries, taxes, etc.).
- Calculate the difference between the two.
Of course, this is only an estimate, and it's best to make this calculation as regularly as possible. The market and the world of work are constantly fluctuating!
💡 To make this forecast as accurate as possible, but also to avoid spending hours a month on it, we advise you to use dedicated, if possible easy-to-use, software like Fygr. Designed for small and medium-sized businesses, Fygr connects directly to your bank accounts. It retrieves your data in real time, so you can see your cash position at any given moment. It also enables you to create forecasts in just a few clicks, with the option of integrating several scenarios to cover any eventuality.
A word from the Expert
Another quick way to analyze cash requirements is to analyze financial ratios.
Examples include the quick ratio or even the interest coverage ratio for large companies. As its name suggests, the quick ratio is a quick calculation that gives an initial idea of cash requirements. It provides a clear measure of the immediate liquidity available to settle imminent debts and disbursements.
How can you reduce your cash requirements? Our 3 tips
Unsurprisingly, good cash management plays a major role in reducing the cash mismatches that are detrimental to your company.
This is particularly true for structural factors, on which you can have a real impact.
#1 Adopt the right strategy with customer payments
Delays in customer payments are one of the main causes of high Working Capital Requirement, and therefore of the need for cash.
To reduce it, start by reducing authorized payment terms, or even by demanding cash payment. For obvious commercial reasons, it's possible to do this on a "customer-by-customer" basis (grant extra time to your best customers, for example).
So how do you avoid real late payments? Here, you need to :
- establish a well-established invoice dunning procedure;
- implement a customer risk management policy. For example, if you suspect someone of being a bad payer, ask for cash payment, or even avoid doing business with them.
#2 Negotiate more with your suppliers
If it's worthwhile reducing your customer payment terms... it's just as worthwhile extending yours with your suppliers! In other words, it's time to put on your negotiating hat 🧢.
But as suppliers are sometimes in the same situation as you cash-wise, it's best to offer them a few benefits in return, such as long-term contracts.
💡 Another solution: diversify your partners to gain flexibility.
#3 Manage your inventory more efficiently
The aim? Avoid over-stocking, synonymous with tying up cash.
It's up to you to find the method best suited to the reality of your business, since the most important thing is to fill your orders!
👉 For example, a just-in-time ( JIT) approach means you receive deliveries of raw materials or finished goods shortly before they are needed for production or sale.
The reorder point method, on the other hand, involves defining when to trigger a new supply order, based on actual demand.
🤓 Discover other techniques, as well as our invaluable advice, in our article dedicated to supply management.
How to finance cash flow requirements? The 4 methods you need to know
😱 An urgent need for cash that can't be met quickly by applying the previous tips?
Don't panic, it's possible to finance it before the situation gets out of hand.
Method 1: The bank loan
One of the first reflexes of companies is to turn to the banks to obtain a loan. However, it's important to anticipate both :
- the interest to be paid ;
- the time required to negotiate with the bank.
💡 There are schemes perfectly suited to cash flow needs, such as overdraft credit. This is a kind of authorized overdraft, allowing you to withdraw funds from your account at short notice in excess of the available balance, up to an agreed amount.
Method 2: Commercial discounting
This technique consists of granting a discount to a customer on condition that he honors his invoice more quickly, or pays cash.
Admittedly, the final amount obtained will be less, but you'll avoid damaging cash flow discrepancies.
What's more, this method is much simpler to deploy than those involving banks, for example. Handy when you need cash urgently!
Method 3: Factoring
Factoring, also known as factoring, is a financing method whereby you sell your trade receivables to a company ( the factor ) in exchange for cash. company (the factor) in exchange for immediate payment, usually a cash advance of between 70% and 90% of the invoice value.
The factor then collects these receivables and pays you the remaining balance, less service charges, once the payments have been received.
👍 The advantages of this method are twofold:
- you convert trade receivables into immediate cash;
- you also transfer the risk of non-payment to the factoring company.
Method 4: The Dailly law
The Dailly Act enables you to assign your trade receivables to a financial institution, such as a bank, in exchange for immediate financing.
Thanks to this assignment, you benefit from a cash advance without having to wait for payment from your customers. The bank then becomes the owner of the receivables concerned, and collects them directly from the debtors.
What does cash flow mean?
Every company is confronted at some point in its life with a need for cash.
It can be structural. Implementing best practices can help reduce it.
It can also be cyclical... and therefore difficult to anticipate. In this case, depending on the extent of the problem, it's best to finance the cash requirement quickly, using practices such as overdraft credit or factoring.
Whatever the case, your mantras should be " anticipation" and " good management". And why not reinforce your processes with software support, which is sure to make you more precise?
Article translated from French