5 insightful tips for ensuring your business’ cash flow stays healthy
Consistently looking at methods of improving your business’ cash flow is key to maintaining a healthy and successful company. But as Australia enters its first recession in 29 years, it’s more crucial than ever before.
Last week, official data showed that the Australian economy shrank in the first quarter of 2020 and Australian Treasurer Josh Frydenberg declared that Australia has entered a period of recession. This can be nerve-wracking news for anyone, regardless of the size of their business.
As one of the biggest impacts of a recession on an individual level is loss of employment and income, your employees may be looking to you for some sense of security in these uncertain times.
Here are a few practical ways you may be able to improve your cash flow right now to help keep your business above water until the economy is back on its feet:
1. Re-think your office
Rental payments for office leases are a large cost for businesses and the work-from-home arrangements brought on by the COVID-19 pandemic has business owners asking if they need all that space.
In 2015, the Quarterly Journal of Economics published a paper demonstrating the benefits of working from home. The research showed that from a study of 1,000 employees of a travel company based in China that worked from home for nine months, the company saw a 13% increase in performance and a 50% drop in employee-quit rates.
While this example doesn’t factor in the added strain from COVID-19 of families trying to balance caretaking for children and family members, it does shine a light on how businesses may be able to not only reduce expenses and improve cash flow in the future, but improve productivity overall.
If your business has been running smoothly while having staff work from home, it may be worth considering downsizing your office space (or removing it completely if relevant) and freeing up some serious cash. Or, if you decide that you do need the space, it's a good time to try for a better deal on your lease terms.
2. Review your Cash Conversion Cycle
A great way to identify ways to improve your cash flow is to look at the Cash Conversion Cycle for your business.
The cash conversion cycle is the amount of days it takes to convert inventory purchases into cash. It is defined as:
Days Sales Outstanding + Days Inventory Outstanding - Days Payables Outstanding
- Days Sales Outstanding - the number of days it takes to receive cash from sales
- Days Inventory Outstanding - the number of days that inventory is held before it is sold
- Days Payables Outstanding - the number of days between receiving inventory and paying for it
Put simply, the less time there is between paying for your inventory and receiving cash from your sales, the better. This is because it means that you're less likely to run into cash flow issues and require funding.
Analysing each component of the cash conversion cycle carefully will help to identify areas of inefficiency that can be improved to shorten the cycle and improve your business cash flow.
For example, instead of outlaying the full cost of inventory and production for customer orders, you might consider asking customers for upfront payments to help cover that initial cash outlay.
Another way to improve cash flow is to be ruthless with the amount and type of inventory you keep on hand. Naturally you want to be able to produce goods efficiently to satisfy orders on a timely basis, but carrying too much stock can tie up valuable cash and also increases the risk that stock becomes obsolete and isn't used at all. Optimising inventory levels, including selling inventory that may not be used, will improve Days Inventory Outstanding and in turn help your cash conversion cycle.
Improving your Days Payable Outstanding by extending the time between receiving stock and paying your suppliers is another important lever for improving the cash conversion cycle and reducing cash flow gaps. That being said, if you want to maintain your stock's quality, it's important to maintain strong relationships with your key suppliers. So, paying them too late is inadvisable.
Depending on the relative cash flow situations of you and your suppliers, there might be an opportunity to either extend payment terms to improve your Days Payable Outstanding or receive a discount for paying early. Although paying early doesn't improve your cash conversion cycle, the discount can go towards funding the extended cash flow gap.
3. Get on top of your invoices
Days Sales Outstanding is a critical component of the Cash Conversion Cycle and having cash tied up in unpaid invoices is a frustration and stress for many businesses.
The amount of time between when an invoice is issued and when it is paid can be broken into two parts. The first is the terms specified on the invoice and the second is when your customers actually pay the invoice. As many small business owners can attest to, the difference between the two can be considerable.
It is common for industries to have generally accepted credit terms which can act as a reference, but it's important to always include a discussion of the invoice terms in any negotiation. If your customer is a bigger business, they might try to bully you into longer payment terms. In these instances, it's important to stand your ground, as funding the cash flow gap can be costly.
Streamlining efficiency in your invoicing is also important. This is because it may help you to not only bring in payments faster, but also identify potential disputes and resolve them faster. If you’re not using an accounting software provider such as Xero, MYOB or Quickbooks to streamline this part of your business, you may want to consider doing some research around potential platforms to use.
Accounting software can provide invoice tracking, instant notifications for invoice reminders, as well as facilitate online payments from businesses. This may help you to not only be paid faster but help make your business look more professional.
Sending out your invoices on time every month and keeping dates consistent can help to establish expectations and encourage more timely payments. Further, using software that allows for online payments or auto-deductions from other businesses may potentially improve your cash flow.
For more tips on getting your invoices paid sooner, please refer to our "Managing your accounts receivable in 2020" blog post.
4. Reward early repayments, deter late payments
If you’ve tried all the strategies to get your invoices paid sooner and still feel that some businesses are dragging their feet to make timely payments to you, you may want to consider offering discounts for early repayments and charging fees for late payments.
It may seem counterintuitive to offer discounts, but some businesses may need that extra incentive to help you get your invoices paid in a timely manner, improving your cash inflows.
However, it's very important to properly understand the cost of offering the discount compared to the savings gained by closing the cash flow gap though. Often these discounts don't not seem like much, but once converted to an annual interest rate, they can often be very expensive.
Further, if you work with businesses who chronically make late or overdue payments, you may want to consider adding late payment fees or interest as means of compensation. This way you can add additional charges or interest to the original balance of your outstanding invoices.
5. Invoice financing
Alternatively, you can use an invoice financing platform, like Earlypay, to bring forward the cash that's locked up in unpaid invoices. The benefit of using an invoice financing provider is that you can receive funds from outstanding invoices the same day, removing the stress from waiting for customers to pay. Most invoice discounting arrangements are undisclosed, so you can maintain your customer relationships and they won't ever need to know that you’re using an invoice financing service.
Earlypay also has great integrations with the accounting software platforms Xero, MYOB and Quickbooks, that make the lives of business owners, their bookkeepers and accountants easier.
If you think that your business can benefit from Earlypay's modern invoice discounting facility and would like to find out more, please contact our team today on 1300 760 205.