Managing your Cash Flow – Part 3.
Saturday, March 20th, 2010IMPROVE THOSE COLLECTIONS FROM CUSTOMERS.
If you’re making a profit every month yet still battling with cash flow, there’s every likelihood your book debts – the amounts owed to you by your customers on credit – has got out of hand. Now, it’s clear that if your business is growing then it’s likely that your customers’ ‘book’ is also growing; and one needs to take that into account when considering strains on cash flow – but, what is vital is that your ‘book’ is not growing out of proportion to your sales. A key performance indicator to keep tabs on in this regard is what is known as the “debt collection period”.
Extending credit to customers can be very risky, especially in the retail sector these days, when job security is a thing of the past. In fact, for most small retail business, I would suggest you don’t sell on credit at all. It’s cheaper, in the long run, to let the Credit Card institutions carry the risk – even though the initial charges they levy are – in my humble opinion – nothing more than a legalised protection racket! So, if you’re going to be buying raw materials to make something for a customer, make sure you take a deposit in advance to cover what you’ll be buying.
If you’re in the business of extending credit to the commercial sector, you need to be even more diligent. In today’s business world, credit agreements are signed with gay abandon and often without thought of being honoured. Investigate your commercial customers carefully – before they become customers. Take into account the business sector they operate in – because some sectors are worse than others! And, whatever you do, don’t allow too much leeway beyond your normal credit terms. Customers will very quickly learn to take advantage of you. Whatever you do, be consistent so that your customers know exactly what to expect from you, every time!
Nowadays, we have a highly mobile working population in South Africa, many of whom can be difficult to trace. If customer expectations or the nature of your business compels you to sell on credit, you need to manage the risk with a great deal of diligence. People today also tend to be shameless when it comes to honouring their debts. In fact, quite often, they will deliberately close a business down today, to avoid having to meet their obligations, and open another one tomorrow, selling exactly the same product!
This is even more important nowadays (2009) after the introduction of the New Credit Act in South Africa. If you don’t screen potential credit customers well enough, you may find it almost impossible to recover your money from them through the courts!
Customers who pay late (or not at all) cost you money by reducing your cash flow and directing your time towards collections rather than making more sales.
The person you employ to do this collecting job should be experienced in the art of debt collection (because it is an art!). I like to refer to them (fondly!) as “dragon ladies.” This doesn’t mean they are completely unapproachable, (or that they breathe fire!) but they have learned, generally speaking, not to take ‘No!’ for an answer.
The job function can best be described as that of Debtors Controller or Credit Manager. Employ the best one you can, pay her well – she’ll be worth her weight in gold! (And please – I’m not inferring that men cannot do this job – it’s just that women seem to reign supreme here in most businesses!)
And don’t avoid getting involved in the collection process yourself! In fact, it will probably be critical if your business is going to survive.
It may be worthwhile, particularly with those ‘sensitive’, large customer accounts that, though they tend to pay late, they buy a lot from you. Get to know your customer’s business and his routines with regard to payment, and then use it to your benefit. You may need to get in the car and go and collect the cheque yourself. People find it very hard to say no to someone eye-balling them from across the desk! Once you’re there, talk to his staff, have a good look around – and listen to other suppliers who sell to him. You may pick up a disturbing trend – that his business is already on the slippery slope – and in this way you can negate any further losses.
STOCK MANAGEMENT
Some of you may ask, “What has stock management to do with cash flow?”
Well, every bit of stock on your premises, that remains unsold, ties up cash. It is quite simply ‘cash on the shelf’. And, the longer it stays on the shelf, the more it deteriorates and, of course, the longer it keeps cash out of the system.
It is vital therefore, that every item of stock is analysed on a regular basis. Make sure you take time out to study your inventory list. Your analysis should include some of the following
Unless you have a computerised stock management system, or you have very few items of stock, this analysis will be very difficult, if not impossible for most small businesses to do. I would definitely advise having such a system in place, particularly if you carry a wide range of stock items for re-sale.
When it comes to stock management, it is generally accepted that The Pareto principle will apply. For those of you who haven’t heard of this principle, it is often known as the 80/20 Rule. Richard Koch, who authored a book with this title, says this:
“The 80/20 Principle can and should be used by every intelligent person in their daily life, by every organisation, and by every social grouping and form of society. It can help individuals and groups achieve much more, with much less effort. The 80/20 Principle can raise personal effectiveness and happiness. It can multiply the profitability of corporations and the effectiveness of any organisation. It asserts that a minority of causes, or effort, usually lead to a majority of the results, outputs, or rewards.”
To look at this principle practically from a stock management point of view, it is quite likely then, that 80% of the number of stock items you carry will account for only 20% of the value of your stock. Therefore, if you spend time just looking at those items which account for 80% of your stock value – and that will usually only be 20% of the items you carry – you will invest a great deal less time managing a great deal more of your investment.
It is also likely that the number of stock items which account for the greatest portion of your sales (say 80% by volume) will probably only account for about 20% of your gross contribution to overheads and profit, by value.
It is important, therefore, to be able to identify where most of your risk lies, so that you can take steps to maximise your profits right down the line; and – enable you get rid of those slow-moving stock items, which tie up a lot of cash.
By managing your stock in this way, you will be able to identify the goods that generate a higher return, and you will be able to minimise the effects of the lower margin items on your overall profitability. It also means that you will more than likely carry an optimum level of stock, minimising the amount of cash tied up in it.
There are a number of different stock management systems around, some of which are very sophisticated and will never be used by small business. (This includes ‘Point-of-Sale’ (POS) systems).
However, I would recommend that most small business adopt the following view with regard to their stock on hand – and for ease of reference I will refer to it as the ABC system. Quite frankly, you can call it whatever you like, as long as it means something to you and you’re consistent in your application of it.
Businesses that use this system divide their stock into three different categories:
The B group can be managed through periodic (weekly or monthly) checking. This group is comprised of usually fairly fast-moving items, but they may be smaller and of lower unit value. They also need a computerised stock program to be well-managed, but in this case, I would recommend checking at least once a month.
The C group can be managed more simply through something called the Red-Line Method. In this case, re-orders of goods are only placed when enough stock has been removed from a bin containing the inventory item, to expose a red line that has been drawn around the inside of the bin. A typical C group stock item would be bolts and nuts. In this case, you just want to have reasonable idea of their security – that they’re not being pilfered on a regular basis!
The point of having these control systems in place is to manage your cash investment in stock. Stock that remains unsold ties up cash and does not generate a profit until it is sold at a profit.
If it stays on the shelf too long, it will deteriorate – or simply go out of ‘fashion’. (Try selling a carburettor for a car these days!)
Quite obviously though, it is important that ALL stock items are kept on a computerised stock system from an administrative point of view, but the MANAGEMENT of them (which takes time!) can be done differently.(if you would like some advice on how to set up a simple, yet effective stock management system, please contact us.)
