Who reads their financial statements from their accountant?
Be honest now, it’s OK to admit that you don’t read them.
Great, not that many, as I suspected.
OK, who understands the difference between profit and cash?
Not many.
That’s not surprising, it takes a bit to get your head around the difference between the two.
Profit is the money left once expenses are paid.
Some people think business owners can take profit to the bank.
If only!
Profit is used to pay for any new equipment or materials needed for the business to grow.
And unless you buy a politician or two, you pay taxes out of profits as well.
Only after paying for growth and taxes do owners get to take money home.
Read out the definitions of profit and cash.
Talk through the various items on the table:
GST
Loan repayments
Interest on loans
Cash spent on assets
Cash received from sale of assets
Depreciation
What the calculation of profit does not show is how much of that profit needs to be retained to allow the business to grow.
In other words, to invest in more stock, materials, plant and equipment.
Available cash, on the other hand, is affected by how long our customers take to pay us, how long it takes us to pay our suppliers, whether we are growing as a business, what we are drawing out of the business in personal spending, our loan repayments, our income tax payments and the new assets we need to buy (for example, a new truck) from time to time.
The link between profit and cash is simply timing - we call this the Working Capital Cycle.
For example, if you’re a service provider, your Working Capital Cycle is this: You sell services to a customer.
Once you’ve invoiced your customer, that amount increases your accounts receivable total, that is, what your customers owe you.
But that money isn’t in the bank yet, it’s sitting in your accounts receivable ledger until you get paid.
And that’s the cycle.
If you’re a manufacturer, the cycle works like this: To make your goods, you purchase stock and materials.
You may have to pay some suppliers immediately, others may allow you to pay on the 20th of the following month.
You manufacture your goods and at any point in time you will carry work in progress or stock of unfinished goods.
Once you receive an order for goods from a customer you make a sale.
You invoice that customer and the amount of that invoice is now in your accounts receivable ledger.
You now have to wait for your customer to pay you.
So, you can see that it takes some time, depending on your type of business, to convert whatever it is you make, or whatever the service is you provide, into cash.
To understand the cashflow effect of this on your business, you need to calculate your own Cash Conversion Cycle.
Let me show you what I mean by that.
Let’s take a look at a real example - a wholesaler.
That wholesaler buys stock from suppliers and has until the 20th of the following month to pay for that stock, which is an average of 35 days.
So, on average, he must pay his suppliers 35 days after buying the stock.
He isn’t able to sell stock the moment it comes into the warehouse.
Some stock sells quickly, other stock takes longer and eventually some stock has to be discounted to get it to move at all.
On average, he holds on to stock for 65 days.
When he sells the stock, he provides credit terms to his customers, but a number of his customers are not observing those credit terms.
He has worked out that on average it takes 45 days for customers to pay him.
So now we can calculate his Cash Conversion Cycle - 65 days average stockholding plus 45 days to get paid by customers less 35 days credit provided by suppliers equals 75 DAYS TO CONVERT INPUTS TO CASH.
Now do another example, say a service provider, on the flipchart, to reinforce their learnings.
Hopefully it’s now obvious to you that the shorter the Cash Conversion Cycle, the better the liquidity (cash room to move) in your business.
If you’re a manufacturer, wholesaler or retailer, to calculate your cycle you’ll need to know your:
Average supplier payment terms in days
Average stockholding in days
Average debtor days
If you’re a service provider, to calculate your cycle you’ll need to know your:
Average supplier payment terms in days
Average work in progress days
Average debtor days
NOTE: Do not get technical here about how to calculate these metrics and whether, for example, you should take an average of opening and closing stock to calculate average stock days.
This is Accountanese and won’t add value.
When you engage your clients in Cashflow Management Coaching, you can gradually teach the finer points of calculating such metrics.
OK, so let’s say you’ve calculated your cash conversion days.
What’s the impact on actual cash in the bank if you work to shorten the cycle?
Let’s look at a worked example.
Relax, it won’t be this complicated.
Explain the example.
The impact on cashflow of shortening your cash cycle can be incredible.
Here we have an example of a manufacturer, initially with a Cash Conversion Cycle of 76 days.
By focusing on reducing debtor days by 9 and inventory days by 6, the business has released more than 52k of cash.
That’s 52k off the overdraft, 52k in the bank, however you want to look at it.
These are the sorts of numbers that we can help run through with you, to see the impact on your business of shortening your cash cycle.
But you can’t just release this cash without doing something differently.
To achieve this sort of cashflow improvement, you need to have a plan.
Here are the four actions you need to take to improve cashflow.
Prepare a Cashflow Forecast and make this part of your annual business planning.
Hands up those of you in the room who prepare a month by month forecast every year?
Fantastic.
This is what our most successful clients do.
Who finds the thought of doing a Cashflow Forecast scary?
That’s OK if you do.
The first time you prepare one it can be confronting.
You’re talking about money, facing cashflow challenges.
That’s important - they won’t go away.
When you have your forecast in place, however, there’s a sense of peace and relief that comes with that.
You can share your Cashflow Forecast with the bank to help build better communication and a stronger relationship.
You’ll be able to predict those months when there is more cash going out than coming in, for example, when it’s tax time.
You’ll also know in advance about any seasonal fluctuations in your business.
You won’t be flying blind anymore on the issue of cashflow.
Many of you are on Xero.
Whatever your accounting or reporting software, your forecast needs to be incorporated into or built in that software so that you can report actual results against forecast, every month.
This enables you to recognise where you are against your target.
You’ll learn how to become aware and comfortable with your cashflow cycles and where you can improve them.
Having a Cashflow Forecast in place is one thing.
Using that knowledge to change how your cash flows is another.
To do that, you have to understand your Cash Conversion Cycle and improve the business processes that can shorten it.
And you have to set some goals.
Having someone to encourage, support and even nag you as you work on your business is the fastest and easiest way to get ahead in business.
That person should be independent, not your spouse.
That’s soft coaching.
Who has a business coach?
That’s fantastic.
In what ways does that help?
There are many causes of poor cashflow.
Here are the top seven.
Poor accounts receivable process - resulting in debtor days (the time between billing and banking) being too high, stifling your cashflow.
Accounts payable process - a review of all suppliers terms may identify ways to improve cashflow or just get better Terms of Trade.
Carrying stock for too long means full shelves but an empty bank account.
This is no different if you’re a service provider with work in progress that is yet to be billed.
Maybe your debt / capital structure needs to be reviewed.
Perhaps your debt should be consolidated and paid off over a longer term.
Maybe you need to have an honest look at your drawings from the business, or the business needs an injection of capital to fund its growth.
Often significant cashflow and interest charge improvements can be achieved with a regular review of existing debt.
Overheads.
Every business should do a thorough review of its overheads every year.
Low gross profit margins is another way of saying that your variable costs are too high.
There are a large number of strategies that you can implement to improve margins.
Finally, sales levels just being too low to support overheads and other cash demands on the business.
This comes down to how viable the business is right now.
If the business is in high growth mode, and sales are increasing rapidly, then the business needs finance to support that growth, and we need to review a financing plan.
If the business isn’t in growth mode, we need to focus on how we grow sales.
Let’s now look at some strategies we can put in place in each of these seven areas.
I want you to get involved here.
Ok, so what are some of the ways we can shorten our Cash Conversion Cycle by getting paid faster by our customers?
Try to draw ideas from participants.
If none come, suggest a couple to get them started.
Review Terms of Trade - clarity, risk, late payment
Discount for prompt payment
Bill faster - on completion, with interim billing
Easy payment alternatives - Xero online invoicing, credit card, direct debit, etc.
Fix debtor control process - document existing, review, fix
Implement a Xero add-on that chases money owing for you
What are some of the ways we can improve our accounts payable processes?
Try to draw ideas from participants.
If none come, suggest a couple to get them started.
Ensure the business is not incurring late payment penalties
Ensure prompt payment discounts are taken
Review all supplier agreements - payment terms, prompt payment discounts, delivery charges
Review payments process
Spending budgets in place
Now, what are some of the ways we can shorten our cash cycle by moving stock faster?
Try to draw ideas from participants.
If none come, suggest a couple to get them started.
Review stock ordering systems
Use technology to better manage stock reordering and slow moving stock
Slow moving stock policy
Shrinkage controls
Stock control process - document and communicate to team
Ok, so how can we improve our debt structure?
Try to draw ideas from participants.
If none come, suggest a couple to get them started.
Review interest rates, fixed vs.
variable
Review term of loan, is this right for the business?
Review owner drawings (don’t avoid this discussion)
Consider new investment, by owners or from new sources
How can we reduce our overheads?
Try to draw ideas from participants.
If none come, suggest a couple to get them started.
Explain that these are your fixed costs such as phones, rent, IT costs etc.
Review annually
Get a better deal with suppliers (IT, server costs, phones, website and Internet, insurances, power, fleet costs, recruitment fees)
ROI on marketing spend?
Reduce?
Go paperless
Controls over staff expense claims and use of credit cards
Get expense budgets in place
Review org.
structure - outsourcing / offshoring of roles or elimination of contractors
Our GP margin is what is left from sales value after deducting variable costs such as stock for resale, materials and labour.
Try to draw ideas from participants.
If none come, suggest a couple to get them started.
Reduce rework / wastage / errors (explain the potential cost to a business)
Improve systems and efficiency
Capture and bill time better
Talk to suppliers, can you get discounts for prompt payment?
(Add warning: this could increase your Cash Conversion Cycle.
There will be trade-offs between profit and cashflow to consider.)
Then explain that there are five ways to increase sales, being:
Increase customer retention rates.
Generate more leads.
Increase conversion rates.
Increase transaction frequency.
Increase transaction value.
You won’t have time to fully explore the five ways to increase sales.
This would take some time and it’s impossible to cover them all.
There are literally hundreds of ways to increase sales.
All of these come under one of these categories.
It will be much more effective if we go through the relevant ways for you one-on-one as part of our Cashflow Management Coaching service.
Simply talk through the pricing.
State your price and shut up!
You have four possible courses of action after today’s session:
Do nothing: that was an interesting event but I think I’ll just box on with what I’ve always done.
Retreat: that sounded a bit scary and hard, I think I’ll go back to the business and hide.
Take normal amounts of action: yes, I think I need a Cashflow Forecast but I can do this myself.
Most likely this will lead to doing nothing or retreating.
Take MASSIVE amounts of action: I get it, I know I need help and these guys know my business better than anyone else.
Ask if anyone has any questions.
‘The three most dreaded words in the English language are ‘negative cash flow’.’ - David Tang
Hopefully after attending today’s event, these are words you’ll never hear again.
Thank everyone for their participation.