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Cash is always king, not just when you're in a crisis.

Improving cash flow is a systematic process of:

  • measurement;
  • forecasting; and
  • taking action in careful steps.

The causes of slow cash flow

At the simplest level, tight cash flows are due to one or more of the following:

  1. Sales are less (or higher) than expected
  2. Collections from sales are less, or slower, than expected
  3. The cost of sales (including production, selling and delivery) is higher than expected
  4. Expenses, including the owner's drawings, are higher than expected
  5. Capital expenditure, including debt repayment, is higher than expected.

A detailed analysis of these five factors and their underlying causes will usually raise important strategic, marketing and operational issues.

Through measurement and forecasting money flows in a cash flow model, the combination of factors which have the most impact can be identified and understood - a process which is referred to as a "sensitivity" analysis. Solutions for improvement are suggested by the high impact factors.

To get this kind of information, the cash flow model must have sufficient flexibility - not usually found in a simple spreadsheet because of the complexity of the relationships between the business variables.

Business cash flow is crucially about timing. In practice, when cash is received and paid out can often be more important than how much, especially in the short-term.

Why an accurate cash flow model of your business is essential

A typical "back of the envelope" cash flow calculation, or even a simple spreadsheet forecast, cannot easily take into account the relatively complicated timing relationships between a business's Balance Sheet items and its Profit & Loss statement.

This can lead to one of two results:

  1. To compensate for the uncertainty, excess working capital is maintained to cover contingencies. In other words, you've got "lazy money" tied up in cash on hand, inventory and debtors - money which is not earning a proper rate of return; or
  2. Working capital shortfalls arise unexpectedly, often made worse because of Murphy's Law - the "bad luck" of several cash flow drains happening at the same time.
In either case, the costs of inefficiency, which could include excess interest payments, lost investment opportunities and damage to trading relationships, all remain significant risks.

Failing to ensure enough cash is available to fund the high inventories and receivables (balance sheet) which accompany high sales (profit & loss), is the reason why many good businesses have gone broke.

Just Having a Good Cash Flow Forecast is Not Enough

Of course, merely having a cash flow forecast by itself achieves nothing, what's crucially important are the actions which follow. The purpose of the cash flow model is to test and predict the effect of movements in the variables, which determines the best actions and their order of priority.

The only alternative is guesswork, with a much higher risk of getting it wrong.

Summary

Whether it's survival or just business-as-usual, improving business cash flow means:
  1. Accurately modelling the business to show both balance sheet and profit & loss behaviour
  2. Testing the sensitivity of the model to movements in individual items. This can also involve the examination of key strategic, marketing and operational assumptions
  3. Using the knowledge gained, to take prioritised actions

Preparing a fully flexible working cash flow model is usually not expensive or time consuming. Using our experience and the right software tools we're able to develop a fully-analysed cash flow model in less than a day for most businesses.

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