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Finance Essentials for Business Leaders

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  1. Module 1: Introduction to Finance
    5 Lessons
  2. Module 2: Financial Concepts and Principles
    5 Lessons
  3. Module 3: Financial Planning and Cash Flow Management
    5 Lessons
  4. Module 4: Building Your Financial Model
    5 Lessons
  5. Module 5: The Financial Implications of Business Decisions
    5 Lessons
  6. Module 6: Interpreting Financial Data and Analyzing Performance
    5 Lessons
  7. Module 7: Managing Finance Through Your Business Life Cycle
    5 Lessons
  8. Module 8: The Requirements of a Modern-Day Finance Function
    5 Lessons
  9. Module 9: Positioning Your Finance Team for Growth and Expansion
    5 Lessons
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Cash is key for the success of most companies, allowing you to finance your business activities, invest more in generating growth and to exploit any opportunities throughout your journey. Having more cash available also helps to avoid over-leveraging the business with debt financing and unnecessary equity dilution from fundraising. However, business resources are often so focused on running and growing the company that they do not place enough focus on effective cash flow management.  

Business trading generates regular cash inflows and outflows across a working capital life cycle, in addition to other routine or one-off activities throughout the year. It is important to understand the nature of your cash flows, what you can do to improve them, and to forecast and respond to any shortfalls in cash.

This article outlines some simple routine processes to help improve your cash flows and working capital cycle, which will better-position your company to generate cash and borrow money when required.

Working capital cycle

Here is a summary of the working capital cycle:

The working capital cycle is a crucial element in understanding the flow of resources into and out of your business. It involves managing debtors, creditors, and inventory to ensure that cash is available when it’s needed. When managed correctly, the working capital cycle can help to maximize profit while providing financial stability over time.

Business leaders need to understand the working capital cycle in order to manage their company’s finances effectively. It is important to have a good understanding of the impact that debtors, creditors, and inventory have on cash flow, as each can affect it in different ways.

Debtors are customers who owe money to your business for goods or services provided. To ensure that your business receives the payment it is due, debtors must be managed carefully. This includes setting payment terms, collecting payments on time, and dealing with overdue accounts.

Creditors are businesses or individuals to whom you owe money for goods or services purchased. To ensure cash flow remains positive, it is important to keep track of creditor payments and pay them on time. Late payments can lead to extra costs or a decrease in credit rating, so it is important to adhere to agreed payment terms.

Inventory is the goods that your business buys and sells. Managing inventory carefully is essential for cash flow as it affects both debtors and creditors. Excess stock that isn’t sold will tie up cash, while insufficient stock can lead to lost sales.

Managing your customers

Finance leaders should ensure you are working closely with your sales teams to influence and understand the payment mechanisms within each sales contract.

Your finance team should also be carrying out the following routine tasks:

  1. Undertake credit references on new customers: credit checks are becoming very popular for new customers in advance of offering them credit facilities. You should consider whether to do this on a semi-regular basis for any key customers.
  2. Raise invoices as early as possible: typically as soon as the goods or services have been provided. However, also think about where it may be appropriate to bill earlier; for example: up-front deposits, key milestones or ongoing monthly direct debits.
  3. Set clear credit terms and chase payments regularly: the majority of sales are made on credit and it is important to set the appropriate credit terms. Communicate these effectively and put in place robust procedures to regularly chase any late payments. Consider the need for early payment incentives, penalties for late payments and to stop trading with overdue customers. Many companies also consider invoice discounting where appropriate.

Managing your supply chain

It is also essential to manage cash outflows to across your supply chain, in a similar manner to how your customers take credit from you.

Business leaders should provide input into supplier negotiations to ensure that you are pushing hard on credit terms. There are many easy wins to defer payments through extended credit terms, thereby increasing your cash balances and improving your working capital cycle. This is particularly important to high growth businesses or companies with a negative working capital cycle, who may otherwise end up having to raise additional capital.

Maintain ongoing communication with your operations team to determine where you should be holding off or deferring payments to suppliers. There are an incredible number of instances where finance teams pay suppliers without having any idea whether they have satisfactorily delivered the services that they are billing for.

Maintain a positive credit rating for your business: you will need your own strong credit rating in order to build as much credit into your supply chain as possible. Form a plan to maximize your credit rating in case your suppliers perform credit checks on you!  Ensure that you are in full compliance with relevant laws and regulations, including company filings, tax returns and business payments.

Managing your inventory levels

For companies who have inventory (stock), it is essential to optimise your stock levels to develop the correct balance between having sufficient stock to meet customers demands, versus having too much cash unnecessarily tied up.

To optimize your stock balances, you will need to build sufficient lead times into your customer delivery schedules or be able to reliably forecast their future demand. You will also need to properly understand the lead times within your supply chain and have an alert system in place to signal when more stock is required.

As well as eating up cash, excessive stock levels create a number of unnecessary business costs including storage, security, insurance and risk of obsolescence.

Cash flow forecasts

You should forecast cash on a regular basis to check that you have sufficient cash levels to meet your daily business needs, including during your typical monthly cash cycle.

Strong cash flow forecasting will also increase your chances of successful fundraising or debt financing when required. You should be aware of the best ways that you can raise cash quickly, should the need ever arise.

Summary

Robust forecasting and strong cash management is essential for all companies regardless of your size, growth and profitability. Most cash and working capital controls are easy to implement as long as your finance team dedicates sufficient focus and has strong levels of communication with the rest of your business. There are also many software tools available to help you. 

Effective cash flow management and forecasting will also:

  1. Minimise your future capital requirements, avoiding unnecessary business costs and equity dilution.
  2. Make you more attractive to potential investors and lenders who regard you as a safer bet.
  3. Open up the possibilities of alternative sources of finance, allowing you to raise more capital at a lower cost.