Positive Cash Flow and Smart Financing Solutions
When building a business, good cash flow is key to success. Linda Frohlich unpacks when you should get finance to grow your business.
The biggest challenge most business owners face is cash flow. A lack of cash flow stifles growth and can even lead to business failure. When cash flow is tight, most business owners start looking for debt funding.
While debt funding can be an excellent and effective growth tool, if accessed for the wrong reasons, it can actually do more harm than good, creating debt that business owners cannot afford. Linda Frohlich, Executive Director at Sasfin, explains how you can unlock cash flow in your business and when it makes sense to access debt funding.
UNDERSTAND YOUR CASH CONVERSION CYCLE
A business’s cash conversion cycle is the length of time it takes a business to convert its investment in inventory and other resources into cash flow from sales. “Your cash is tied up in the production and sales process before you are paid by your customers,” explains Linda.
“The shorter your cash conversion cycle, the healthier your cash flow and the greater your ability to pay your bills and suppliers without incurring penalties.”
Some business models have better cash conversion cycles than others. A business like Amazon, for example, whose cash conversion cycle in 2017 was negative 30,6 days, has an extremely good cash conversion cycle.
The online retail giant ensures its inventory moves through the cycle quickly, and it collects cash from consumers before payments to suppliers are due. This means that Amazon has a lot of working capital and is able to invest in its own growth.
“One of the best ways to solve working capital problems is to unlock cash flow within your own business,” says Linda. “Evaluate your inventory cycle and whether you have stock sitting too long on shelves.”
It sounds simple, but many businesses do not manage their stock well, with the result that cash is sitting in goods rather than liquid in the business.
Another common problem that affects cash flow and working capital is overtrading. “One of the biggest issues we see are companies that overtrade and get themselves stuck in a debt cycle,” Linda explains. “In simple terms, a business that is overtrading has orders, but not the infrastructure to meet those orders.
If there’s a clear growth strategy in place matched with the right financing vehicles, this growth can be planned, controlled and executed, but many entrepreneurs want to run before they can walk. “When this happens, the business will invest in expensive fixed assets to meet orders, and then the necessary orders don’t come in, or something happens to disrupt the business.
Now the business is playing catch-up, and the business owner needs finance to cover debt.” According to Linda, the biggest cause of overtrading is failing to plan cash flow. “This is one of the first questions we ask: Do you have a strategy in place and a cash flow projection, not just for this year, but this month, week, and even on a day-by-day basis?”
If you haven’t adequately planned your cash flow, you could be over-investing in growth or orders.
“If you can see you’re in danger of overtrading, you can look for areas to cut costs and unlock cash flow in your business. Once you have overtraded however, it’s often too late and you end up in a debt-cycle you can’t afford.”
Another key error many business owners make is using the deposit from one contract to kick-start another contract. “There’s a domino effect when this happens. The business very quickly gets totally out of kilter, and the owner never quite manages to get on top of his finances. To avoid this trap, concentrate on finishing the job you have. Ensure that you allocate the funds that you get to where you lent the money from — no matter what.”
According to Linda, this is essential when managing cash flow. “Business owners often believe that funding a second project from the first (when it’s not finished and the money isn’t in the bank) will help them grow. Instead, it just kills their business. Cash is king and never borrowing money can cap your growth, but you need to understand the difference between healthy debt and bad debt.”
So, when is the right time to finance growth?
“There’s a cost to accessing finance, which means it’s essential that you’re accessing it to help you grow your business, rather than to service debt,” says Linda.
“If you borrow money to enable the growth of your business, the finance cost is actually part of the cost of your sales.
But if it’s to service debt, or you can’t afford the finance, you’ve got a problem and it will only damage your business.” According to Linda, it’s important to understand your margins. If you can sustain the cost of finance with your margins and if the finance product that you’re looking at makes sense for your business and growth plans, debt funding is a viable growth tool.
“The upside is that a financier can provide you with growth, because they’re going to give you access to cash, enabling you to grow your business. We think of it as a working capital solution rather than debt.
We evaluate businesses and business owners to gain a deep understanding of the entrepreneur’s needs, first to ensure affordability and second to evaluate if the right product is being utilised to drive growth.”
According to Linda, business owners should always balance revenue to debt and income to profit. “If you aren’t managing your cash flow, it’s unlikely you will secure a loan from a bank. Banks want to fund growth and help entrepreneurs boost their businesses, not create more unaffordable debt for business owners.”