Over the last three decades that I have been working on small and medium enterprises (SME), one aspect that stood out across all of them irrespective of the size and industry was their constant problems in managing cash flow!
Cash flow management is not, always, about sourcing additional funds for the organization but more importantly optimally utilizing the available funds! The problems associated with cash flow management are going to get even more pronounced in the years to come. This can be attributable to fiscal measures being adopted by the regulatory authorities to rein in inflation as much as banks themselves becoming increasingly becoming risk averse to lending. The fiscal measures have a dual impact – firstly availability of money from the banking system is going to get a little more difficult and second terms under which banks lend are potentially going to be stiffer.
Given a situation like this, it is imperative for SME’s to start looking the following three aspects to effectively manage their cash flows.
1. Start Preparing a rolling 4 weekly cash flow forecast – The management of cash flow is akin to driving a car for two reasons again. First, what is seen is the most manageable part i.e. the objects right in front of the driver. The skill of the driver is managing the left extreme (that is if you are driving a right hand drive!). It is there that you invariably get hit. The second is that you cannot always drive looking at the rear view mirror!
Four cash flow forecast helps you to manage this better by virtue of understanding your potential receipts and payments. To manage it even better try and categorize your payments at Critical (the show-stoppers), Major and Others. Many experts recommend preparation of a “Thirteen Week Cash Flow Forecast”. In my view, most SME would initially find even managing a four week statement a challenge driven by the low visibility that have on the receipts. So to get a good handle on the management I would strongly recommend a 4 week statement.
The other aspect is the extent of accuracy required in the forecast. I have hand innumerable debates on this. In my view the variation should not exceed 3% in the next immediate week, 7% in the second, 15% in the third and 20% in the fourth.
2. Manage your Receivables – Have a close watch on the receivables. More often than not, customers do not pay because they are not asked. Using the classical ABC analysis works wonders on this. “A” category represents all receivables that cumulatively account for about 65% of the total receivables, “B” account for 25% and “C” account for 10%. All “A” category items should be monitored every week, the “B” fortnightly and “C” monthly. This enables greater focus on the receivables and more effective. Offer cash discounts to customers who are willing to pay ahead of the credit cycle. There are enough customers who are having surplus cash and are looking at better utilization of the funds!
3. Manage your inventory – Inventory is a silent killer in most organizations. Here again the use of the ABC method helps you to manage the inventory and keep it at the minimum. Organisations should revisit their purchase policy and work with the vendors to reduce the cycle time for the delivery. This will help them to reduce the lead time for the delivery thereby the need to hold additional stocks. Another aspect is to review all the obsolete or potentially obsolete ones. Invariably many organizations tend to retain stocks, which are not currently in use, in anticipation of use at the later date! This procrastination is bound to hurt them badly. First, they are locking up funds and probably losing an opportunity in the bargain. Secondly there is every possibility that the stock item would lose its value and probably end up in the scrap yard. The stock could be used in a lower grade application or in a worst case scenario to sell it. The funds freed up on the process will improve the cash velocity. In difficult times the number of times the inventory is turned around is very critical.
Following these simple but effective steps can alleviate the problems. My experiences of working with many organizations in the segment have had very positive effect. I also read a analysis by CRISIL that every 1% increase in interest rates reduces the profitability of SME’s by 14%. These steps not only give the breathing space but also invariably improve the profitability. So why not give it a try?!