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September 5, 2014

Cash is King

A2“Cash is King”. This is a familiar adage in business and we don’t believe that there is any business owner who has never been required to commit some thought to the process of cash flow management. Perhaps we are confident in making this statement, because cash flow is truly such an indiscriminate area in finance, affecting business through the entire spectrum, from micro-enterprises to large multinational corporate companies, as was recently demonstrated by the near-collapse of African Bank.

Cash flow is the lifeblood of any organisation, especially in a small and medium enterprise (SME) context, since it is often harder for SMEs to obtain short-term finance (or bail-outs). Yet, many small business owners, despite understanding the implications of cash flow pressures, often don’t have the necessary tools to proactively manage cash flow. In order to effectively manage cash flow, however, it is necessary to first understand the process.

To do this one should look at how transactions move from the income statement through the balance sheet until they get converted to cash. If, for instance, a company which is in a growth phase provides debtor terms of 30 days and is trading in the goods market, the following might be applicable:

  1. Capital expenditure

In order to sustain growth, capital expenditure will need to be invested in advance to expand capacity, while the return on investment will only materialise in the future when excess short-term capacity is fully utilised.

  1. Inventory

Cost of sales will often be payable long before raw materials have been converted to finished goods during the production process, while a debtor will only be created once the converted finished goods are actually sold.

  1. Debtors

Once finished goods are sold, a debtor will be created, but the company might wait up to 30 days (or more) until the account is paid and the proceeds will reflect in the bank account.

Cash spent will therefore in many cases end up in the balance sheet as operational assets (such as production machinery), inventory and debtors, causing a time delay between expenses paid and cash being generated. This effect of cash inflows usually lagging cash outflows creates cash flow pressures that need to be managed.

We will explore ways to proactively manage cash flow in newsletters to follow, but common tools in the SME context might include access to short-term finance, managing debtor and creditor payment terms, managing inventory levels and inventory flow, and a general understanding of your personal cash flow context.

ASL_3For now, we wish you positive cash flow until our next newsletter, but should you wish to talk to us about any cash flow related issues, please contact Malan Botha (malan@asl.co.za) or Arnold Scholtz (arnold@asl.co.za).