Understand and manage your cash requirements so that they are no longer a problem
As every company knows only too well, cash flow is of vital importance: it guarantees the company's ability to meet its financial obligations, but also to invest in its own development. So it's best to look after it!
But despite a healthy turnover, cash can sometimes run out - sometimes dangerously so 😰. It's important, then, to understand what factors give rise to such a phenomenon so you can anticipate it better, but also to know how to finance an urgent cash requirement if the need arises.
There are many possibilities and solutions available to you. This article, co-written with Eric Desquatrevaux, Managing Partner and founder of Avizo, provides an update.
Cash requirements: definition
Cash flow requirements define the situation in which a company no longer has enough cash to cover its various expenses, in particular :
- paying salaries ;
- payment of suppliers
- ongoing expenses such as premises rental or maintenance costs.
💡 This concept is similar to that of Working Capital Requirement (WCR), which refers to current cash flow shortfalls due to the operating cycle.
Most organisations, even those whose business is running smoothly, are faced with this cash requirement. This is particularly true when it is the result of structural factors.
The factors behind a company's need for cash
Structural factors
👉 Here, we're talking about factors relating to the intrinsic characteristics of a company's business, which regularly affect its cash flow.
Overly long customer payment terms
Most organisations, particularly those operating in BtoB, grant their customers fairly long payment terms, sometimes amounting to up to 60 days.
😬 The problem is that they have already incurred costs to :
- supply the product or service to the customer ;
- run their business properly in general.
And that creates an obvious cash flow mismatch.
Supplier payment terms that are too short
Staying with the theme of payment times, if your suppliers' payment times are too short, you find yourself having to disburse funds more quickly than you generate income.
Too much stock
Excessive stock levels are also a factor in cash flow requirements, since you have to pay for them before you can sell them to make up the difference. In other words, it ties up funds without generating immediate income, thereby limiting the availability of the cash you need to run your business.
☝️ Hence the importance of following a well-honed stock management process, to avoid over-stocking while ensuring product availability to customers.
Investment
Investment (purchase of fixed assets, financing of development projects, etc.) can give rise to a structural cash requirement.
This is because the operation requires significant cash outflows in the short term... with the aim of stimulating growth and profitability in the long term. But there is a time lag before it actually generates profits ⏳.
Seasonality
Finally, seasonality often leads to significant fluctuations in cash flow.
👉 For example, a ski resort experiences peaks in activity and income during the winter months, but faces slower periods during the summer.
This variation leads to temporary imbalances between cash inflows and outflows, requiring careful management to ensure financial stability throughout the year.
Economic factors
👉 Sometimes the need for cash increases significantly compared with what is generally accepted. Various factors are involved, sometimes difficult to anticipate, and more damaging.
In all cases, managing your cash flow correctly will greatly limit the consequences of both structural and cyclical factors.
Sudden growth
Sudden growth, and therefore the need to meet rising demand, considerably increases cash requirements:
- various investments (in equipment, software, premises, etc.) ;
- hiring additional staff
- increasing stocks.
All of this leads to a substantial cash outflow in the short term, before the business generates enough income to make a profit.
Late payment by customers
Here we are no longer talking about the agreed payment terms mentioned above.
We're talking about real late payments, customers who break the rules... putting you in the red, as the time lag phenomenon described above gets worse!
☝️ Not to mention the fact that if the situation gets out of hand, you will probably have to embark on costly legal proceedings, which will further destabilise your finances.
External events
Finally, when we talk about factors that are difficult to anticipate, we inevitably think of external events such as natural disasters or conflicts.
Interruptions in the supply chain, reduced demand, customers affected who can no longer pay or who cancel their orders... there are many potential consequences that could affect your cash flow.
A word from the Expert
To avoid the consequences of cyclical factors having too great an impact on cash flow, solutions can be envisaged to better prepare for these unforeseen events.
Cash management also involves building up a cash reserveor taking out insurance to cover certain risks .
The aim of this strategy is above all to absorb financial shocks without compromising current operations, and to protect against specific events that could have a significant impact on cash flow, by taking out appropriate insurance cover.
How do you calculate your cash requirements?
To be able to act as quickly as possible in the event of a problem, it's best to anticipate your cash requirements!
And there's no better way of doing this than with cash flow forecasts. Presented in table form, they enable you to forecast cash flows over a defined period, usually monthly or quarterly.
👉 Here are the steps to follow to produce them:
- Make a list of all potential cash receipts over the period under review (sales, loans, investments, etc.). Be as exhaustive as possible.
- Do the same for disbursements (payments to suppliers, salaries, taxes, etc.).
- Calculate the difference between the two.
Of course, this is an estimate, and it's best to do this calculation as regularly as possible. The market and the world of work are constantly fluctuating!
💡 To ensure that your forecast is as accurate as possible, but also to avoid spending hours each month working on it, we recommend that you use dedicated software, such as Fygr, which is as easy to use as possible. Fygr is designed for very small businesses and SMEs, and connects directly to your bank accounts. It retrieves your data in real time to give you an instant cash flow report. It also lets you create forecasts in just a few clicks, with the option of integrating several scenarios to cover every eventuality.
A word from the Expert
Another quick method of analysing cash requirements is to analyse financial ratios.
Examples include the quick ratio or even the interest cover ratio for large companies. As its name suggests, the quick ratio is a quick calculation that gives an initial idea of cash requirements. It provides a clear measure of the immediate liquidity available to settle imminent debts and disbursements.
How can you reduce your cash requirements? Our 3 tips
Unsurprisingly, good cash management plays a major part in reducing the cash mismatches that are harmful to your company.
This is particularly true for structural factors, on which you can have a real impact.
#1 Adopt the right strategy with customer payments
Customer payment delays are one of the main causes of high working capital requirements, and therefore of a need for cash.
To reduce it, start by reducing these authorised payment periods, or even by demanding cash payment. For obvious commercial reasons, this can be done on a "customer-by-customer" basis (give your best customers extra time, for example).
So how do you avoid genuine late payment? Here you need to :
- establish a well-functioning invoice dunning procedure;
- implement a customer risk management policy. For example, if you suspect someone of being a bad payer, ask for payment in cash, or even avoid doing business with them.
#2 Negotiate more with your suppliers
If it's worthwhile reducing your customer payment terms, it's just as worthwhile extending yours with your suppliers! In other words, it's time to put on your negotiating hat 🧢.
But as suppliers are sometimes in the same situation as you cash-wise, it's best to offer them a few benefits in return, such as long-term contracts.
💡 Another solution: diversify your partners to gain greater flexibility.
#3 Manage your stocks more efficiently
The aim? Avoid over-stocking, which is synonymous with tying up cash.
It's up to you to find the method best suited to the reality of your business, since the most important thing is to fulfil your orders!
👉 For example, a JIT (just-in-time) approach means that you receive deliveries of raw materials or finished products shortly before they are needed for production or sale.
The reorder point method, on the other hand, involves defining when to trigger a new supply order, based on actual demand.
🤓 Discover other techniques, as well as our invaluable advice, in our article dedicated to supply management.
How to finance cash flow requirements? The 4 methods you need to know
😱 Do you have an urgent cash requirement that can't be met quickly by applying the advice above?
Don't panic, it's possible to finance it before the situation gets out of hand.
Method 1: The bank loan
One of the first reflexes of companies is to turn to the banks to obtain a loan. However, you need to think ahead about :
- the interest to be paid ;
- the time required for negotiations with the organisation.
💡 There are schemes that are perfectly suited to cash flow requirements, such as overdraft facilities. This is a kind of authorised overdraft, allowing you to withdraw funds from your account at short notice in excess of the available balance, up to an agreed amount.
Method 2: Commercial discounting
This technique consists of granting a discount to a customer on condition that they honour their invoice more quickly or pay cash.
Admittedly, the final sum obtained will be less, but you will avoid damaging cash flow shortfalls.
What's more, this method is much simpler to deploy than those involving banks, for example. Handy when you need cash urgently!
Method 3: Factoring
Factoring, also known as factoring, is a method of financing whereby you sell your trade receivables to a company ( the factor ) in exchange for cash. company (the factor) in exchange for immediate payment, usually a cash advance of around 70% to 90% of the invoice value.
The factor then takes charge of collecting these receivables and pays you the remaining balance, less service charges, once the payments have been received.
👍 This method has two advantages:
- you convert trade receivables into immediate cash;
- you also transfer the risk of non-payment to the factoring company.
Method 4: The Dailly Act
The Dailly Act allows you to assign your trade receivables to a financial institution, such as a bank, in exchange for immediate financing.
Thanks to this assignment, you can quickly benefit from a cash advance, without having to wait for payment from your customers. The bank then becomes the owner of the receivables concerned and collects them directly from the debtors.
What do you need to know about cash requirements?
Every company is faced with a cash requirement at some point in its life.
It may be structural. Implementing good practices can help to reduce it.
It can also be cyclical... and therefore difficult to anticipate. In this case, depending on the scale of the problem, it's best to finance the cash requirement quickly, using practices such as overdraft facilities or factoring.
Whatever the case, your mantras should be " anticipation" and " good management". And why not strengthen your processes with software support, which is guaranteed to improve your accuracy?
Article translated from French