Events after the date of the financial statements
September 29, 2014
Cash is King: How strategic placement affects your cash flow position
November 13, 2014

Cash is King: How bargaining power can influence your business model, profitability and ultimately cash flow

A2

We are currently busy with a series of newsletter articles pertaining to cash flow management. In our previous article on this topic we referred to four main components of cash flow, being capital expenditure, inventory, debtors and creditors. In this article we focus on the latter two components.

Michael Porter is arguably one of the most influential business philosophers and teachers in the business world today, and we often use his business models as an internal reference when engaging with clients.

Porter suggested that the profitability (and therefore attractiveness) of an industry is mainly determined by five forces as shown in his Five Forces model:

A2_Graph

Although this model is too complex to adequately discuss in this article, for the purposes of cash flow management we will mainly focus on Porter’s primary suggestion that profitability, to a very large extent, is a factor of the pressure that suppliers and customers are able to exert on your competitive environment, although there are many other factors that may also play a role.

Since cash flow is a factor of profit (we will elaborate on this in our next article), the impact of Porter’s five forces on the cash flow situation of your business can be profound, if you think about it.

If a company, for instance, is reliant on one or two major customers, the bargaining power will automatically weigh toward those customers. This might already place strain on an organisation when negotiating payment terms, and even when collecting payments in line with existing payment terms.

If we were to further assume that there are substitute products or services (to those that your business is offering) already available in the market, and furthermore that entry barriers to your industry are sufficiently low to allow relatively easy access to the market for new competitors, the bargaining power will further be shifted in favour of your customers. At the same time, suppliers might also be provided with a larger market as new players enter the industry, possibly causing a shift in bargaining power in favour of your suppliers as well.

Depending on the competitive situation that your suppliers and customers find themselves in, they might exert their bargaining power in different ways when managing their individual cash flow situations. However, should you find yourself in a situation as described above, any one of the following outcomes might be applicable:

  1. Your suppliers and customers might be in a strong cash flow position, where they are not forced to exert excessive pressure on you in terms of payments or payment terms;
  1. You might already be experiencing pressure from your customers and/or suppliers. This might be causing you to have to juggle payments and will probably prompt an increase in working capital levels, which will need to be financed somehow; or
  1. You might be steering towards the latter situation, without yet realising it.

Whatever your situation, we believe that the key to effective cash flow management is knowledge – the ability to understand your own competitive environment, to understand your own bargaining power within the context of your customers and suppliers, and to understand the further risks that might impact on your personal situation, as well as on those of your customers and suppliers.

Business is an integrated, dynamic network of companies and individuals all trying to use whatever tools they have at their disposal, in order to somehow create a competitive advantage. It is therefore important to understand your place in this network, but also to understand where you are positioned relative to other players that might have an impact on your organisation.

Circumstances can easily change and although change is often a good thing, it is seldom good to be surprised by change. The ability to understand and anticipate relevant risks before they materialise is therefore important in order to pre-emptively mitigate those risks.

A2_aShould you require our assistance in regard to the above, or with any other issues relating to your cash flow situation, please contact Malan Botha (malan@asl.co.za) or Arnold Scholtz (arnold@asl.co.za).