"I spent most of my money on booze, fast cars and women. The rest I squandered." - George Best.

Many owners of businesses, while perhaps not being in the same league as George Best, cannot genuinely tell where their hard earned cash has gone, let alone predict where it will be going in the future. And yet, without a really good understanding of the true dynamics of the flow of cash into and out of your business, you may be on the verge of serious trouble. Some of these dynamics are subtle and will cause hardship if not properly understood and managed. In this article, we highlight just one of these.

Assume that we have a simple business in which fixed and variable costs are constant at R9000 and sales are constant at R12000. The business is therefore profitable.

Compare the following tables to see that if, instead of all our sales being cash, we allow one months credit on half of our sales, we will have a negative cash flow for two months from which we never fully recover.
The key information in these tables is in the third line of each, labelled Cash Required.

CASH ONLY

HALF CASH AND HALF THIRTY DAYS

In both situations, we are generating a profit of R3000.
In the cash situation, we require R9000 working capital, reducing to zero in month four (April).
In the credit situation, we require R12000 working capital, reducing to zero in month six (June).

A simple decision to grant credit on half of our sales for one month results in a two-month negative impact, from which we never recover. We refer to this as the "one times a-half equals minus two" syndrome.

On top of this are the issues of interest on the negative cash flow, abuse of your credit policy and, of course, bad debts.

Cash flow problems come in various disguises, of which this scenario is only one. Others include, but are not limited to, periods of growth, seasonal variations in the demand for your product, periodic payments, granting credit to generate additional sales and of buying in stock to expand your business, meet peak demand or take advantage of bulk orders. All these and others tend to conspire together in different combinations to disguise the situation, aggravate it, or more normally, both. They demand decision-making that cuts across every facet of your business. Without a good understanding and tight management of your working capital requirements along with access to sufficient working capital funding, your profitable business will fail.

Every business needs detailed, precise cash flow projections that take account of these variables so that informed, timeous decisions can be taken in managing them. But that is not enough: every projection reflects one or more assumptions. For your cash flow projections to be in any way useful, you must give explicit recognition to the assumptions inherent in those projections. Finally, you must have a deep commitment to keeping your projections updated on a monthly basis at least. Without all three of these, you are placing your business directly in the firing line of the number one cause of business failure.

Andrew McGregor is a director of the business PLAN. He can be contacted at adml@tbp.co.za or (011) 782 6746.

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