Watch, Optimise and Conserve Cash

Take a guess.

What could completely derail a business and bring it to the state of bankruptcy, irrespective of its size, profitability and longevity?

Running out of cash.

Highly successful companies have faced bankruptcies and one of the major causes has been poor cash management.

In 2007, in US, 400 construction contractors went bankrupt. Nearly half of such bankruptcies were due to poor cash flow management (Source: 2007 Construction Industry Annual Financial Survey,” conducted by the Construction Financial Management Association (CFMA), Princeton, N.J.).

Why is sustained positive cash flow so important to every business?

Simple. The bills never stop arriving and need to be paid on time, be it payroll, rent, utilities or taxes. If the business does not generate enough cash to pay them as well as create a surplus for a rainy day in future, a time will arrive soon when the business will fold up for want of cash, even if it has good products, customer base, market share and profits.

Non-accounting, non-financial people may wonder how can a profitable business run out of cash.

Profits are on paper. If the receivable are of a much longer duration than the payable, if the inventory levels are high blocking cash, if the capital structure of the company is not aligned with the needs of the business model, then running out of cash is pretty easy. Of course if the business is not profitable then the cash out will happen much faster.

Watching cash flow like a hawk is a mental attitude. It has nothing to do with advanced processes and IT systems as they are just tools. If such systems by itself are enough, many large businesses, which had all the advanced tools, would not have gone belly up.

What is the mental attitude that we are talking about which puts cash ahead of all other performance parameters? It is asking the following questions and many more of similar nature.

a. Does my business generate enough profits to cover my costs, generate a surplus, pay the dividend to my shareholders and generate additional resources for a rainy day in future?

b. Is my capital structure (i.e. the combination of debt and equity, short term and long term sources of funding etc) aligned with my business model?

c. How can I negotiate longer payment terms with my suppliers so that the supplier credit will cover as much as possible my inventory and receivable?

d. How do I negotiate shorter payment terms with my customers so that I get my money as fast as possible and also minimise risk of bad debts?

e. How do I select my customers so that I deal with good paymasters only, even if that means sacrificing a portion of my profit margin?

f. How do I use technology and services  available for better cash management? For eg. why not opt for credit cards (which gives say 50 days of free credit) for my employees for their travel needs instead of paying them cash in advance? Or, at the end of each day, how do I bring all my cash into a single bank account for consolidation and better utilisation?

g. From where do I source my inputs so that they reach me fastest so that cash is not blocked for long transit times?

h. How fast the investment I am making now will pay me back?

The opportunities to optimise are endless.

In the technology space we hear the term “cash burn”, where companies plan to “burn” cash through discounts, promotions etc., to acquire more customers.

Is this sustainable?

Definitely not in the long run. This is true especially for those businesses where the stickiness (i.e. loyalty) of the customers so acquired, cannot be guaranteed.

If such a cash burn strategy is based on sound business principles and will ensure customer loyalty in the long term, then it may still make sense for a short period of time. Otherwise, such an approach can only lead to improving the vanity indicators like market share, sales growth etc., but cannot be part of a sustainable and profitable business model.

Many Indian family businesses are extremely successful for generations. One of the main reasons was their internal MIS system, which focused on cash flow. Every day, by the end of the day, they knew how much cash they generated for the day. This was done at a time when computers did not even exist!

Even if such companies failed in the long run, very rarely it was due to cash flow issues.

So watch cash with a hawk’s eye and build a successful, sustainable business.