Business Toolkit

Managing cash flow in the current economic climate

The continuing global adverse economic conditions such as higher oil prices, global food shortages and increasing commodity prices coupled with the ripple effect on the domestic market arising from higher interest rates and higher petrol prices, have several implications for the South African business environment especially on Small Medium Enterprises.

Businesses must be able to respond quickly to the changes in their business environment as failure to do so might negatively impact the financial performance of their business. Because of the time lag in effect, most businesses fail to respond to the crisis at hand immediately but leave it until late when the situation is worse off. This can have drastic implications to a business. Management must have a hands-on approach and have tight controls such as an effective cash flow management system. Proper cash flow management is a critical part of running any business, and it becomes more imperative during the down turn in economic cycle. A business with proper cashflow management policies and guidelines is more likely to succeed than those without.

What is cash flow management?

Cash flow management is the effective management of cash resources, overdraft facilities and other short term funding facilities, debtors, creditors and stock. These variables if managed properly and effectively can result in an optimal cash flow position for the business and the opposite will result if not managed properly.

What is the impact of adverse market conditions on cash flows?

• Sales volumes go down due to lower consumer spending. A negative change in forecasted sales can have a negative impact on stock especially if the stock holding was based on projected higher sales. The business might end with huge unplanned stock holdings. 
• Production costs go up especially if one of the input cost is increasing such as oil prices.
• Financing costs increase.  Highly geared companies tend to suffer more during a high interest rate environment.  The impact is greater with every basis-point increase and further funding from funders is limited due to the perceived high risk environment that their funding is at a high probability of not being repaid.
• Suppliers and customers are also under pressure. Suppliers are reluctant to offer favourable terms or even demanding upfront payments or cash payments for their supplies while customers are struggling to meet their payment obligations. 

How can you manage and improve cash flows given the above impact?

1. Budgets can be utilised as an effective and efficient planning tool for business operations, they help to estimate the future cash needs, sales, costs, profits and overall cash flow requirements.  As a starting point management needs to prepare forecast or budgets taking into account the revised impact on sales volumes, increased input costs etc.  to assess whether the business has sufficient cash for the foreseeable future and to determine the business’s immediate cash requirements. This will alert management of any possible funding shortfall.
2. A sensitivity analysis must be performed on the budgets to assess the impact of any of the key variable, e.g. the impact of any further surprises such as additional increases in the interest rates, reduced sales and increased costs etc. 
3. Management must also on a regular basis review the performance of the business by comparing actual performances against budgets. This must be done at least monthly.  Any deviations from the original budget must be included in the revised budget. 
4. Short working capital cycles are generally preferable and by reducing them they will improve cash flows. 
5. Stock requirements must be looked at very carefully by purchasing only what is needed, limiting bulk orders and volume discounts if the products are not going to generate cash or the cost of holding excess stock outweighs the benefits. 
6. Optimising your stock holding. Just-in-time principle may work with certain business. This will minimise money tied up in stock. Any slow-moving stock should be identified and sold at a discount or auction.
7. Cash is King. Where possible increase cash sales even if it means giving an acceptable discount.
8. Accelerate collections from debtors. It is important to assess the costs related with funding credit customers with the sales lost, due to stringent credit policy. Cash generation could be further improved by offering settlement discounts and persuading customers to pay in advance and improving collection on overdue accounts as well as reducing bad debts. Debtors credit policies age analysis should be reviewed regularly.
9. Negotiate extended credit terms with suppliers.
10. Evaluate the gearing of the company and ensure that assets are financed over the correct term with the right instrument. For example, financing major equipment on an over-draft that will drain cash off the business, is not appropriate.
11. Sell unproductive assets or lease to other companies who may optimally use the asset.

In conclusion, it is advisable that when confronted with cash flow problems to regularly communicate with all the stakeholders i.e. employees, financiers, creditors, customers regarding the financial position of the company.  Always try to talk to and approach your financiers early enough to make them aware of your business conditions, keeping quiet and hiding the problem will not make it go away and it may lead to a business collapse.  Your financiers may be willing to help by rescheduling repayment terms, giving moratorium, deferments or converting some of the debt into equity etc.

The IDC has a Workout and Restructuring Department whose function is to work together with IDC clients in finding the best possible solutions and minimize the risk of business closure.

Watch out for our next article which will give guidelines on what steps and what information is required by financiers to consider a debt restructuring.

Danile Nyalunga
Head of Workout and Restructuring