Any company, big or small needs to manage its cash flow well, just as much as its sales and expenditure. There are many giants that were seemingly doing very well with steeply rising sales and running massive projects, spending lavishly on research and development backed with advertising campaigns, only to see them crash almost overnight. What is the reason for such unexpected crashes? Since we are told that their sales were doing well and expanding, then the root cause has to be poor cash flow management. Cash flow is the difference between your receipts and payments (in cash, whether from bank accounts or from other source). Cash Flow should not be confused with income and expenditure or profit and loss that is quite different from receipts and payments.



To illustrate the difference between income and expenditure (profits) and receipts and payments (cash flow), let's take a simple working example. A small company gets a contact for $ 1,000,000/- and they calculate their cost of production at only $ 225,000/-.

The company is highly bucked at the prospect of making an almost 350% profit on their new contract. With much fanfare, jubilation and congratulations all round, contracts are signed; product is manufactured and delivered to the customer in January. Being a small company operating within a modest budget, it had to borrow from banks at high interest rates for procurement of raw materials etc for this operation.

Customer is paying only in July, which is six months hence. The small company in its eagerness to grab the deal at all costs, had invested all its resources on this special project, and with monthly high interest payments now due to the lending institutions for the next six months until they get their payment from the super contractor to pay off the banks, and being unable to get any further loans, gradually finds itself unable to meet its normal monthly commitments on rents, rates, salaries and wages etc. or keep the production lines rolling for the manufacture of their normal products and already agreed supplies to other customers, even in more their smaller quantities. So the company inevitably crashes, why? Simply because they did not bother to see how their cash flow would work out during the interim period between spending and receiving money; by only concentrating on making a massive $ 775,00/- gross profit on a single contract!

It would be seen that "over investment" beyond their means led to the above crash. If it had been a bigger company with more assets and resources, it could have got away with it by drawing on their excess resources during the period they had to wait for settlement by the contractor. Thus, it is seen that smaller companies are more vulnerable to cash flow problems than their bigger counterparts. The following tips should be useful to avoid similar disasters by managing your cash flow well.

Fast Debt Recovery

You should have a very good control over extending credit to customers in terms of time as well as a maximum limit while always trying to collect your debts as fast as possible so that you could enjoy the benefits of having more working capital. Getting your customers to place their orders online or by fax could help speed up the process of collection. Ensure that you dispatch the invoices along with the goods and that the due dates of payments and the penal rates of interest applicable in case of delayed payments are clearly stated therein.

Formulating a firm Policy of Extension of Credit Facilities and Collection

Each customer should be granted credit facilities on his own merits of proven creditworthiness, possibly in consultation with rating agencies; or by requesting the customer to furnish references. Follow up all late payments immediately with a phone call or a letter or both, failing which legal action may be contemplated for recovery of the debts. Curtail further supplies to a debtor whose account has fallen overdue, until all overdue balances are settled.

Go along with minimal balances in your operating bank accounts

Having a good cash flow position does not mean carrying excess or surplus funds in your operating bank accounts. Instead, judiciously divert some excess funds for re-payment of any loans taken at high interest rates and simultaneously invest in high interest yielding fixed securities or in short call deposits depending on your liquidity position, that is, your ready cash availability from bank accounts, deposits at short notice, good debts recoverable etc. taken together with the estimated cash inflows and outflows for the next two to three months.

The pulse of any business is its cash flow. Therefore strive to maintain it at optimal requirement levels at all times, no more and no less.