People sometimes assume that a growing business is less likely to have cash flow problems but often the reverse is true. Revenue and profit growth can go hand in hand with a shrinking bank balance – all because of a mismatch in the timing of payments and receipts.

In times of business growth, forecasting and planning for cash flow needs is more important than ever.

To manage your cash flow for growth, take into account:

  1. Timing
  2. The Cash Conversion Cycle
  3. Working Capital Ratio
  4. Labour Costs and Revenue
  5. Long term financing for long-term assets

 

1.Timing

Managing cash flow for growth all comes down to timing. Growth requires the purchase of inventory, the hiring of staff, before the revenue comes in. It’s important to manage the timing carefully to ensure the business survives – there’s nothing more tragic than a business collapsing from cash flow issues just when it’s on the brink of success. Manage the cash flow carefully through the growth period and the rewards will follow.

 

2. The Cash Conversion Cycle

For a retail, wholesale or similar business, managing cash flow is very much about managing receivables, inventory and payables. This is often represented using the formula:

Debtor Days + Inventory Days – Creditor Days

In general, you want to minimise the first two and maximise the latter – but with care. You need to balance the desire to keep inventory low with the need to have enough stock to satisfy your customers. While you want to stretch out your creditor terms, don’t do so at the expense of relationships with your suppliers. They will have their cash flow issues too so be sure to talk to them if you’re going outside the agreed arrangements. Pay them early when you can to build up some goodwill and they’ll generally be more understanding when you sometimes need to pay late.

These four numbers are standard KPIs in Calxa and it’s a relatively simple task to create a custom KPI to add them together. Copy and paste the lines below to shortcut the process.

 

Debtors = if ([Debtor Income] <> 0, [Trade Debtors] / [Debtor Income] * 365, null);

Inventory = if ([Annual Cost of Sales] <> 0, [Inventory] / [Annual Cost of Sales] * 365, null);

Creditors =  if ([Creditor Expenses] <> 0, [Trade Creditors] / [Creditor Expenses] * 365, null);

Debtors + Inventory – Creditors

 

3. Working Capital Ratio

The Working Capital Ratio is similar to the Cash Conversion Cycle but looks at the relationship between your Current Assets and Current Liabilities. A ratio of less than 1 (or 100% if expressed as a percentage) is generally seen as an early sign of potential problems.

Current Assets includes not just your Receivables and Inventory but also bank balances and anything else that can be soon turned into cash. Current Liabilities incorporates your Payables but also credit cards, tax and payroll obligations and any short-term financing.

When a business is growing there can be periods where the liabilities increase temporarily before revenue comes in – but this requires regular forecasting and careful management.

 

4. Labour Costs and Revenue

A growing business that relies on sales staff, or any significant inputs of labour, faces different cash flow challenges. There is often a stepped nature to the increases in wage costs and a delay before the new people contribute to revenue.

Wages and Income Manage Cash Flow for Growth Calxa

5. Long-term financing for long-term assets

One trap that is easy to fall into is to purchase long-term assets (such as equipment or vehicles) using cash or short-term loans. Ideally the financing for an asset should match the expected life – so that your business pays for it over time and it doesn’t eat into your short-term working capital.

Plan your Cash flow

In summary, the key to successfully managing cash flow to growth is planning. Estimate your revenue and expenses and use that to forecast your cash flow. It’s prudent to create two or more budgets to fit different scenarios. Business people are inherently optimistic – that’s why we are in business – but it pays to look at what things would be like if the revenue was less than you expect.

Cashflow Scenario Line Chart

Manage your cash flow well and your business will thrive and grow.