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| Beyond Survival-Cash Needs |
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Westpac Beyond Survival #4
Business survival in the 21st Century - Seven key areas of failure
by David Dandie - Westpac Bank
 How much cash does your business need to survive?
It seems obvious to state that cash flow is vital for any business to survive. However many profitable businesses collapse because they couldn’t get the cash flow they needed to support them in the short term. Profit and cash flow are often considered as the same however they are two different things. Profit pays back long term debt and supports growth of the business and cash pays back short term debt and pays for every day expenses. Both cash and profits are required for a business to survive.
If you consider a business who over a twelve month trading period only made enough sales in the first eleven months to meet commitments and then in the last month made a large sale making a fifty thousand dollar profit. The profit and loss for this business will show a full year result as a fifty thousand dollar profit. This will not show that for the first eleven months they were strapped for cash and nearly had to close down.
Understanding how much cash is required to survive the peaks and troughs in business is essential. How much you need will depend on things such as the type and size of business, seasonality, phase of life cycle, stage of growth and infrastructure requirements. What you do with the available cash and how efficiently you manage it, is what is important. This information in dollar and cents terms is best captured in a cash flow budget, the impact of inefficient use of cash is best explained by the Working Capital Cycle.
Cash Flow Budget
Completing a cash flow budget based on sound assumptions is invaluable to any business. It allows you to predict the future, identify cash requirements, plan and monitor business performance, eliminate spot fires and help you, your banker and many others sleep better at night. The cash flow budget should not be stored in the cupboard but should be a living document that is updated regularly. Should the cash flow be completed by your accountant, make sure you understand the information and include all relevant parties in its completion.
Working Capital Cycle
Available cash tends to be tied up in what is known as the Working Capital Cycle (WCC). Every business, regardless of what they do operates this cycle. To start any business cash is required, this cash is then used to purchase stock in order to generate a sale. When the stock is sold it is either by way of a cash sale or is charged to an account, creating a debtor. When the debt is collected the WCC continues on. In a service industry the stock is client base or the service provided.
Imagine in a business that the stock sits on the floor on average for fifty five days and that it takes an average forty five days to collect the debtors. Each dollar tied up in the WCC takes one hundred days before it returns to the cash position and can be used again to purchase more stock in the WCC.
While waiting for that dollar to return, more stock has to be purchased to keep the business operating and to do so, many businesses use their overdraft facility which is costing them money. If there is no overdraft they are using credit funds that could be better utilised elsewhere. The faster you can turn the WCC the faster the dollar returns and the less overdraft or credit funds you have to use. This is where efficiency in debt collection and stock turnover is the key.
Managing cash in any business is important. Many profitable businesses end up closing down simply because they could not get the cash to carry them in the short term. Beyond Survival Workshops emphasise the difference between cash flow and profits, constructs a cash flow budget for a business and analyses where does all the cash go. It will demonstrate the importance on the efficient operation of the working capital cycle, how to improve debtor collection and stock turnover to help increase cash holdings and reduce the overdraft limit.
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