Avoid the perils of poor cash management

avoid perils cash managment v2

There is more than a grain of truth in the notion that businesses often fail because they do not have the cash to pay a key supplier rather than because they have a surplus of liabilities over assets or, in other words, have become insolvent.

Maintaining an adequate cash balance (i.e. liquidity) and carefully managing its cash receipts and payments as part of its normal regular activities is crucial to ensuring that a lack of liquid resources does not become a threat to the survival of a business. Here are some issues for small and medium sized businesses to consider when managing cash flow.

Monitoring bank balances

It may sound obvious but the place to start is to ensure that management knows how much cash its business actually has at any particular moment in time.

Businesses often have a number of bank accounts with various banks and these accounts can be found across a number of subsidiaries. Ideally, cash balances should be summarised and reported on a regular basis, ideally daily or weekly for most businesses, although monthly may be adequate. The bank balances should be reconciled on a regular basis with cash balances recorded in the books to ensure that the balances have been properly verified and that there are no large payments or receipts in transit.

Having established the cash resources of a business it is important to work out how accessible the cash may be for use in the operations to pay employees and suppliers as and when required. Where a company or legal entity has a number of bank accounts, cash may usually be transferred freely between accounts. There may however be restrictions, for example, if a cash balance has been pledged as security against borrowings or some other liability. Alternatively, it may be the case that the cash is held on deposit for a fixed period (say 90 or 180 days) to secure a higher rate of interest and may not be accessible until the term of the deposit has expired.

If a business has a number of subsidiaries, then transfers of cash may be necessary between the affiliated subsidiaries, particularly if one company generates net revenues while the other incurs net expenses. Intercompany financing between such affiliates can be undertaken but care needs to be taken to ensure that a loan from one company to another can be justified. For example, loans from a company with a non-controlling interest may be prejudicial to the minority shareholder if not undertaken on arm’s length commercial terms. Equally, a loan from a subsidiary which is cash positive to one which is cash negative needs to be justifiable on the basis that there is a some prospect that the loan will be repaid with interest in due course. If not, then the cash needs to be provided on a formal basis as permanent capital or equity to the relevant subsidiary. In addition, cash can be extricated from a subsidiary to its parent by the payment of dividends if surplus cash has been generated.

Cash flow forecasting

Once a business has determined its cash resources currently available for use in its operations, it needs to determine how it will generate additional cash and use that cash to pay employees and suppliers.

Most businesses produce a budget for the next 12 months. Ideally, this should include not just a projected income statement but also a projected balance sheet from which a cash flow statement can be derived. This will show whether the business expects to generate or use cash in its operations over the upcoming year. It will also determine if the business has adequate cash for this period or if it needs to obtain either longer term funding, to cover losses or capital expenditure, or shorter-term facilities, to fund working capital.

As well as the budget derived cash flow forecast for the year, it is normally a good idea to prepare a short term cash flow forecast for at least the next two or three months. This short-term forecast should be prepared on a receipts and payments basis focussing on anticipated collections from debtors and planned payments to employees, suppliers and other creditors. Although it can be a challenge, this short-term cash flow forecast should be capable of being reconciled with the longer -term cash flow statement, if this has been analysed on a periodic basis. If such a reconciliation can be done, it is a useful discipline in proving that the two views of future sources and uses of cash are consistent.

With short and longer term cash flow forecast in hand, the finance team should be in a position to work with the rest of the business to manage cash within the group’s available resources or, if necessary, to augment those resources by fund raising activities.

Cash conversion cycle

The cash conversion cycle of a business is the time it takes to create its stock in trade or inventory until the time when its collects the cash from the sale of that inventory. Minimising the time between the supplier payments to manufacture or procure inventory and the collection of receipts from customers buying that inventory is clearly desirable in reducing the cash invested by a business in its working capital.

A business will make assumptions about all stages of the cash conversion cycle in its cash flow forecast. These include the amount of inventory to be held for any given level of sales, the time taken to produce or procure this inventory and the timing of payments to employees and suppliers for the inventory acquired, the normal period of time the inventory is held before it is sold and the time taken to collect cash from customers in respect of those sales.

To manage its cash resources according to its forecast, the primary objective of the management team is to achieve the assumed cash conversion cycle. If possible, the team will seek to better these assumptions, thereby improving cash flow. If the team fails to meet its targets, the business will generate an adverse variance in cash flow compared to its plans. This latter outcome is clearly to be avoided if the business has little headroom in its available cash resources.

Having established a framework and targets for managing cash flow, the specific actions a business may take to optimise its cash resources are largely a matter of common sense and are described in the sections that follow.

Inventory management

Because procuring or producing inventory ties up cash, it is vital that a business accurately determines how much inventory it should hold: too much, and it will needlessly use its valuable cash resources; too little, and it may stock-out in the face of stronger than expected customer demand.

Ideally a business should work to reduce the length of its supply chain so that the time from ordering to delivery of finished goods inventory is minimised. This has the advantage of lowering the risk of stock-outs and also reducing the length of the cash conversion cycle.

In addition, regular communication of inventory requirements needs to take place between the sales, supply chain and finance teams to ensure that the interests of all parties are taken into account in setting the appropriate levels of inventory holdings by product which are required to meet expected demand.

Managing suppliers

The timing of payments to suppliers clearly affects the precious use of precious cash resources of a business. Once a business has contracted for supplies or services, the longer the period before it pays the supplier, the better.

When negotiating the terms of supplier contracts, the procurement team needs to seek not only the lowest price possible for the goods or services, but should also look for the longest possible period from the date of delivery of the relevant goods or services to settle the supplier invoice. Provided the business has a solid credit rating, then most suppliers will allow at least 30 days for payment after submission of an invoice. Depending upon the amount of competition to supply a particular good or service, longer periods may also be possible. Periods of 90 days or more can represent a valuable source of genuine working capital finance to any business that can negotiate such terms.

More controversially, a business that is struggling to manage its cash outflows can defer payment of invoices beyond the agreed settlement deadline. It can do this without informing the supplier but this may lead to a loss of goodwill in the relationship and could affect the supply of goods and services in future. The better approach is to talk to the supplier and explain the reasons for requesting a deferral of a payment. Suppliers may, depending upon the circumstances, be willing to provide a deferral or a rescheduling of payments over an extended period if it is clear that there are benefits to the supplier, perhaps in terms of future business opportunities, to agree to such an arrangement.

Collecting debts

Just as extending the period to settle supplier invoices favours the cash flows of a business the same is true for the early collection of debts from customers.

The sales team of any business needs to focus not only on the pricing of the product or service being sold but also the terms of settlement of the invoices it issues. As with suppliers it is normal to allow a period of up to 30 days to settle invoices to any customer with a reasonable credit rating. In many organisations terms that are longer than this would require the prior approval of the finance team.

To collect cash in advance of the normal settlement date, customers could be offered early settlement discounts to encourage early payment, particularly if the business is in a position where it has a high utility for cash.


Most businesses prepare quarterly VAT returns and pay tax after the filing of the relevant returns.

If a business has flexibility over the timing of sales that attract significant amounts of VAT, then it could consider delaying sales that might occur towards the end of a VAT reporting period to the commencement of the subsequent reporting period. This would gain a three-month deferral in the payment of the associated VAT liability.

Working capital facilities

Where a business has a longer cash conversion cycle and is growing, then it might have significant working capital requirements resulting in the depletion of its cash resources. In such circumstances, the business might consider taking out a working capital facility. These types of arrangements are typically short-term, revolving facilities. The simplest form might be an overdraft facility, but these can be expensive and are risky if they are subject to repayment on demand by the lender.

Suppliers of working capital credit have become more sophisticated and now offer structured facilities secured on the inventory or account receivable that are being financed. Alternatively, receivables may be sold or factored at a discount to face value. This is usually only the case where the customers have, when taken as a whole, a sufficiently strong credit rating for the lender to take on the payment risk itself. Although significantly more complicated to document and to administer, secured working capital financing arrangements like these can offer a more predictable form of finance for a business as well as being a cheaper financing option.

How can DRG help?

The team at DRG has extensive experience helping its clients to understand and manage cash flow and to ensure businesses have access to adequate working capital.

We can also provide the expertise and independent advice necessary to assist its clients in budgeting and forecasting short and longer term cash requirements as well as the actions to be taken to improve cash flow management.

Furthermore, DRG has contacts with and can provide access to a number of banks and financiers willing to provide working capital facilities should these be required.

If you would like to find out more, please do get in touch. We would be delighted to hear from you.


DISCLAIMER: This information is for guidance only, and professional advice should be obtained before acting on any information contained herein. We will not accept any responsibility for loss to any person as a result of action taken or refrained from in consequence of the contents of this publication.




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