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The first thing on most business owner’s minds is the generation and conservation of cash in the business. We are often asked by business owners what appropriate measures should be taken in order to conserve and increase cash flow for their companies. With that in mind, we’ve come up with the following three strategies:
A scenario we repeatedly run into is one where business owners want to improve their cash flow, but while doing so circumvent tracking their revenues and costs. Our experience tells us that this is near impossible to do as there is no metric on which to base improvement. While this may come as a surprise to some, the reality is most companies won’t survive if they can’t keep track of the level of sales being earned (i.e., the “in”) and the money being spent (i.e., the “out”) in the business.
With that said, we recommend business owners frequently track the ins and outs of their operation, including sales invoices and expense receipts. By delaying this process by even a few months, the business owner risks not knowing their profitability, and could face struggling to meet their next vendor or debt payment. These delays may also come as an unwelcome surprise to the owner if the costs are in excess of the revenues and available cash in the business. After all, timing is everything!
New business owners often struggle to handle the various moving parts of their new operation. In the preliminary stages of a business, owners usually take on all roles of the company in order to meet the demands of their customers. In times like this, we often see the owners struggling to keep track of sales and costs of operation. However, we find that being aware of what the business is bringing in, compared to what the business is spending, is a key process.
Benjamin Franklin coined the phrase “time is money”. It holds true as much today as it did back in 1748. The majority of business owners set up payment terms and agreements with their key customers and suppliers early on. For example, a typical customer may have 30 days to pay on their outstanding invoice to the business (a receivable on the business owner’s books). While in turn, the business owner may have 30 days to pay on their outstanding liability to their suppliers (a payable on the business owner’s end). In this scenario, we see that the “in” and “out” are happening at the same time (albeit not necessarily in the same amounts).
For simplicity purposes, let us assume that a receivable and payable are of the same amount (i.e., $100). If the business receives the payment from the customer in 30 days and in turn pays the vendor right after, we see that the impact on the business’ net cash flow at day 30 is $0 – what came in went right back out.
If, however, a business negotiates more favorable terms with either its customers or vendors, the results may be much more beneficial to the operation. For example, if the customer pays within 15 days, and the business can take up to 45 days to pay its vendors, using the same $100 amount, this will enable the business to maintain a $100 balance, or use the excess funds to further business operations for 30 days. This means the business will be cash positive by $100 for 30 days.
By now, you should see that one of the key recurring concepts in our strategy is timing. The faster a business can receive cash from their sales and the longer they can delay payment of their expenses, the greater the benefit due to timing. Of course, the fundamental requirement here is that the business will continuously receive cash from sales in advance of payment to its vendors (rather than a one-time in and out). This way, the business is able to benefit from the value of time in money.
This brings us to the last part of our strategy: taking customer deposits on prepaid sales. A good example of prepaid sales is gift cards. A company will sell gift cards at their face value to ensure the customer will get to spend this face value at the store at a later date. As a result, the company receives the sale and income that day without having any detrimental cost impact to their operations. An example that comes to mind is when Tesla introduced the Model 3. By offering customers the option to reserve a vehicle for $1,000, prior to receiving the product at completion, Tesla essentially had an additional $1,000 to spend in its business operations (hence cash flow).
Although there are many strategies that help businesses conserve and improve their cash flow, the concepts we’ve found to be key to the operation is knowing the ins and outs of your business, and finding ways to use timing strategically in order to best benefit the business. In doing so, business owners may find operational cash flows running smoother and stronger over time.
CPA, CA, CBV
Partner - Advisory Services
Mike has over 25 years of experience providing accounting and business advisory services, with a focus on the Canadian insurance industry.
CPA, CA, CBV
Alex Wong is a partner at Smythe Advisory and is focused on being a trusted business advisor to his clients.
CPA, CA, CBV
Director of Valuation Services
Paul Woodhouse focuses on providing financial advisory and litigation support services to clients.
Gagandeep specializes in M&A advisory engagements, as well as business valuations in the contexts of management buyouts and succession planning.
Arthur’s mandate is to assist Smythe clients in Western Canada in preparing for and executing business divestitures or acquisitions.