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Cash is king 

First published in SME Magazine November/December Issue
Tips to manage cash flow and options for short-term credit
There is an old saying in business: ‘Cash is king’. Cash is the single most important element of survival for businesses particularly small medium enterprises (SMEs). While profitability is important, cash flow is also important and crucial to pay the bills.

Small businesses often cite an inability to control cash flow as one of their many challenges and some have failed due to cash flow issues. In times of high volatility, cash flow management is even more important as cash serves as a buffer against the instability and fluctuations in the global marketplace.

Cash and Profit
Many businesses grow their revenue and increasing profits, sometimes at the expense of their business liquidity.

Optimisation of working capital is often considered to be of lower priority compared to other corporate objectives and strategic financial measures such as earnings, sales and capital expenditure.

A common misconception is that accounting profit equals cash. However, recognising profit and actually being paid can affect cash flow. This difference in timing can result in a huge gap between profit and cash flow, particularly in situation of rapid growth in credit sales and shrinkage of cash sales.

Consequences of poor cash flow
Many SMEs might have experienced symptoms associated with poor cash management but may not have recognise its signs.

    Some common symptoms of poor cash management include:
  • Regular cash shortages in meeting current liabilities and servicing debt

  • Problems in obtaining financing for working capital
  • Continuous calls for funds from subsidiaries

  • No clear plans to reduce the need for financial leverage by better using internal resources

  • Inefficient management of inventory, receivables and payables.

    The consequences of poor cash flow management can influence a business both directly and indirectly. These include:
  • Increased interest and bank charges – external funding will result in extra costs which will affect profit and cash flow.

  • Missed business opportunities – poor cash flow will hinder a business from taking advantage of opportunities that would allow a business to grow.

  • Poor relationships with suppliers – being constantly late with payments will cause tension and may eventually lead to a loss in the business relationship.

  • Employee morale – delays or late payment in staff salaries will lead to a decline in overall employee morale, especially if they are worried about the long term future.

Improvements to cash flow management
Strong cash management policies and practices will have a positive impact on overall business performance by enhancing liquidity and strengthening of the underlying business. Cash management is beyond managing receivables and payables; which involve stretching payment to creditors and making additional effort at debt collection.

These initiatives are short-term in nature and reactive to business situations. Instead, businesses should consider incorporating long term sustainable strategies in their cash flows management to negate the crunch during distressed periods.

    Some of these strategies include:
  • Improving forecasting – cash flow forecasting needs to be accurate and realistic. A range of scenarios and risks must be considered for a business to understand the key drivers and restraints on their cash position. Inadequate technical skills and the lack of commitment by managers typically results in poor forecasting.

  • Reconsider capital expenditures – a review of capital investment plans are especially crucial in times of changing business environment. Special attention should be paid to plans that require ongoing funding. Projects that are seriously over budget and behind schedule should be scrutinised to prevent them from becoming a cash ‘bottomless pit’ which does not deliver their promised benefits.

  • Build a ‘cash culture’ – Management should communicate a cash oriented mindset throughout the organisation. By incorporating cash as a component in key performance indicators (KPIs) and incentive regimes, executives are assessed not only on sales and margins but also on credit management and timely debt collection.

  • Short term credit – there are many types of short term financing available in the market these days. Businesses should identify the availability of these short term credit facilities to plan their usage effectively.

  • Options for short term credit
    Short term credit allows a business to fulfil immediate financial obligations that arise from day-to-day operations. Business with cyclical operating conditions or those engaged in international trade are more likely to use these facilities. There are a couple of ways a business can seek short term credit including:
    1. Overdraft – extension of credit from an institution beyond the available balance. It is revolving in nature and does not have a fixed repayment period. The amount of credit facilities can be negotiated. An overdraft arrangement allows businesses the flexibility in managing its cash for operating activities such as payment to creditors or payroll.

    2. Letter of credit – a document from a bank guaranteeing a buyer’s payment to a seller within the credit period. This allows a business to negotiate better credit terms with suppliers.

    3. Short-term loan – a liability that must be repaid within a year or less with interest. It has a fixed repayment period and is not revolving in nature. It allows a business to meet immediate liquidity needs for working capital.

    4. Bill of exchange – an arrangement whereby one party pay a fixed sum of money to another party at a future date. An exporter can grant credit to an importer for goods shipped by drawing a bill of exchange to the same amount and credit period.

    While short term credit is a useful cash flow management tool, over-reliance on it may cause a business to take on more financial risk to finance its operations. Additionally, late payment of credit lines will result in poorer credit ratings and costlier financing in future.

    Sustainable cash flow management
    In conclusion, short-term cash management is usually the easiest to implement and may pull a business through during difficult times. However, to achieve sustainable, long-term improvements in cash management, companies need to ensure that the ‘cash culture’ becomes ingrained and a natural part of everyday life for everyone in the business.

    Just as most people are used to considering the profit and sales implications in their business decisions, they should also take into account the cash flow implications. Targets, reporting and incentives will all have their cash flow and working capital dimensions. However this requires visible commitment and strong enduring leadership from the top.

    This article is contributed by Heng Wee Koon and Lai Chung Meng. They are the Partner and Associate Director of Transaction Services, Advisory at KPMG in Singapore respectively. The views expressed are their own.