Business owners understand this, yet a surprising number do very little cashflow planning. Failing to forecast cashflow and plan ahead can cause even the most profitable businesses to rapidly fall into a death spiral.
Failing to forecast cashflow can ruin a profitable business
Since 2020, we have been seeing dramatic changes in cashflow expectations. Snarled-up supply chains and high demand mean suppliers are able to ask for up to 50% deposit payments up front. If your business needs to pay half before delivery of materials, the other half when goods are delivered, and then your customers are paying on the 20th of the month following an invoice, this immediately creates a major cashflow challenge.
The construction industry has been hit particularly hard by this problem, and we have seen several companies fail due to cashflow problems that could potentially have been averted with better forecasting and short-term cashflow management (i.e. working capital requirements) - businesses that on paper, made a reasonable profit and had millions in turnover.
For example, many don't plan for that gap between up-front payments for suppliers and delayed payments by customers. Unfortunately, because these businesses had scraped through in the past, they think they'll be able to do so again - but economic conditions change. Without forecasting, using actual profit and loss, cashflow dries up and they can no longer pay their suppliers, employees and IRD.
This doesn't need to happen. It's likely these businesses can survive if they use effective tools for cashflow management well ahead of time, based on existing supplier and client contracts and up-to-date profit and loss data.
Effective cashflow forecasting saves spiralling businesses
On the flipside, we recently worked with a rapidly-growing business where cashflow forecasting meant it survived in the face of some big challenges. It's an innovative company with a product in high demand, even expanding into overseas markets. However, it had outgrown the business model that had worked in the early years. Wanting to support other small local businesses, it had extended customer payment terms up to 60 months. In the first few years, rapid growth allowed it to keep up with costs so the directors didn't think they had a cashflow issue.
However, as orders quadrupled, five-year payment terms meant this system was no longer sustainable. Debtor financing, at a cost of tens of thousands of dollars each month, was causing an extra drain on resources as the higher interest rates and administration costs associated with this type of financing took a toll.
After improving its cashflow, using forecasting tools to see where the gaps are, and building stronger payment relationships with suppliers and customers, cashflow has improved and the company can now keep growing sustainably.
5 tips for improving your cashflow
- Review your payment terms – they are a vital tool for business success
Payment terms seem to be a 'set and forget' for many Kiwi businesses. It's an ideal time to review this overlooked tool, because the right payment terms can drive an enterprise with better liquidity. Cashflow forecasting will show you the difference it makes when you tweak these terms, and the impact of scenarios where debtors pay in 90, 60, 30 or 14 days. At what points can you still pay your bills?
We are now seeing payment term renegotiation in many industries, as businesses work with their customers to shorten payment cycles. So, don't be afraid to revisit your payment terms.
- Create and enforce cashflow management policies, and review them regularly
Managing your debtor list is essential – it's not the most enjoyable job in your business, but it is one of the most important. Stay in touch with debtors, and have a system in place for remind them and pursuing aged debts. Establish the point at which a human needs to step in and the actions they will take, and when a debt will be referred to a third-party collection agency.
- Consider investing in systems for better debt collection
Automatic reminders and statements can be extremely useful when it comes to managing debtors. If you invest in effective systems or processes to help you better manage outstanding payments, your costs can often be rapidly recouped.
When debtors pay earlier, you have more cash to invest in growing a resilient business. You can use excess cash effectively to, grow your business or simply earn more by investing somewhere else.
- Identify problem areas and work on solutions quickly
We see several recurring cashflow problems with the potential to seriously damage business performance, yet these are often not addressed. For example, businesses that rely heavily on only two or three major customers and have no plan in case one stops paying. In the long term, they need to work towards diversifying their customer base; in the short term, they should be maintaining excellent relationships with those VIP customers, and have a contingency plan in place in case they don't pay.
Another common issue is disagreements about invoices. Take the time to get every invoice exactly right, because errors at your end can lead to months of delays. Having thousands of SKUs can mean mistakes easily creep in, and companies must spend weeks reissuing invoices and credit notes; these are preventable drains on time and money.
- Undertake regular short-term and long-term cashflow forecasting
Without cashflow forecasting, you are reacting to what's in the bank account – it's expensive, stressful and unsustainable.
Forecasting prepares you for every likely situation. Depending on your business, you may need to undertake cashflow forecasting monthly, weekly or even daily. The ultimate goal is long-term stability, so you can keep growing a successful business throughout the ups and downs of the economic cycle.