Cash is King

First the basics - some would say the obvious – the fundamental requirement in keeping a business alive is cash. Not customers, and not profit – you can have both of those things and still have a business failure. Cash is like the lifeblood of a business. That’s why the maxim, “Cash in King” is so true.

Anyone in business should have heard this. But it may still seem confusing to you how you can be profitable and run out of cash and fail. If that’s the case then you can think more clearly about this by remembering one word – timing. Very simple example – I buy a car for £5,000 and sell it for £10,000. There is no question that I have a good customer and I have made a profit. But if I have to pay for the car tomorrow, and I am not going to get money from the customer until next week, then my business will fail if I don’t have £5,000 cash to pay for the car tomorrow.

The basics of cash flow management, really, are that to maintain the level of cash required to survive (zero or, perhaps, less if you have an overdraft facility) you must have more cash coming in than going out.

Sometimes the business is so consistently loss-making that it requires constant propping up by lenders and investors. Cash going out is more than sales receipts coming in, so more and more capital is required to ensure that the cash does not run out.

I worked with one such small business. The thing that amazed me at the time was that even after the last lot of capital had been used up, even though each month’s accounts showed a loss, even with no overdraft facility, the business managed to continue two months longer than anyone thought possible... and long enough to allow a rescue.

How did we do that? I think there were three key things that we did (apart from the obvious cost control actions that were necessary):

First, we produced cashflow forecasts in detail every week. The forecasts went forward 6 months - weekly for the first 3 months, then monthly after that. The base forecast detail was based on the same assumptions as the profit and loss forecast and went to quite a low level of detail. It showed very clearly when the shortage of cash would occur, how long it would last and how big the shortfall would be.

To get a feel for the level of detail, on the income side we forecasted three categories – i) receipts from debtors (i.e. cash for invoices already raised, based on payment terms and specific knowledge of each customer); ii) receipts from customers on projects not yet started, but the work has been ordered (i.e. so we know roughly when we should be invoicing for the work, how much and how long it will take to collect the cash); iii) receipts from deals in the sales pipeline and therefore may or may not come to fruition (i.e. there have to be probability judgments around which proposals will be successful, what the agreed prices will be, what invoicing timing will be agreed, and when the projects will start).

On the expenses side we forecasted different types of expenditure depending on its materiality and timing. Salaries, bonuses and commissions were monthly and fairly predictable. Rent was payable quarterly. PAYE and VAT also had a predictable pattern. Loan interest payments were fixed. Then staff expenses and other invoice payments were the variable elements. We knew from the profit and loss forecast and budget, compared to the actual P&L for the previous year, what a reasonable assumption of monthly expenditure would be. But we also knew that some of that had VAT added to it, some with foreign GST, some with no tax, and we knew we could flex the timing and size of the payment runs to a certain extent.

Second, we relentlessly monitored the bank account and the debtor list. The CFO would get copies of the bank transaction prints every day and check against what we forecasted. If customers did not pay when they were expected to, we would chase the project managers and customer account directors as soon as the invoices became overdue. As a result of that we got to the point where we had only a handful of invoices overdue for collection from customers.

Also, since our forecast of receipts went down to customer and invoice level, we were able to tick off what we had received compared to what we were expecting.

Thirdly, we knew what payments we could flex and therefore what our limitations were on payment runs. The extent to which we had cash to pay suppliers was determined by whether the inflows came in as expected. We knew we could flex PAYE payments by a few weeks, but there was a limit. And we knew that to keep the business going we had to keep paying the payroll, keep paying the loan interest, keep paying the suppliers. But we also knew that unless we started to make a profit we had to be careful with the timing of those supplier payments, and so we had a fairly tense few months when we only just stayed on the right side of some of our key suppliers.

Conclusions: Accelerate the inflow and slow down the outflow and you can make the cash go a lot further. Also, with careful, detailed monitoring and forecasting you can see a lot more accurately exactly when you need the rescuer to come in, when the investors need to increase their contribution, or (heaven forbid) you need to call the administrators. That's putting it negatively, but it applies positively as well - having surplus cash is not just a safety cushion. Surplus cash allows you to invest in the future without having to ask for extra investment from shareholders or ask for more borrowing. It also allows you to pay bigger dividends to the shareholders. Knowing how big the surplus will be and when it will occur will help to plan investments or dividends or the like.

So whether your business is loss-making or making a healthy profit, detailed, regular cashflow forecasts are essential.