Published on 21 January 2011 by Tony Groom

Profit and turnover are, of course, important measures of business performance but when times are as difficult as they are at the start of 2011 and many businesses are finding themselves in difficulties the main focus must shift to cash.

Cash flow is the most immediate indicator of the way a business is performing and can also provide a warning signal that action needs to be taken to prevent a slide into insolvency.

Close attention to cash flow should give a clearer picture of the immediate state of the business but while it may be possible to adjust to strengthen incomings against outgoings this is only going to be a holding operation.

The business must also look at its business plan and business model, preferably with the help of a turnaround adviser.  An objective outsider working as part of the business team to secure its medium and longer term future may identify fundamental weaknesses that undermine the ability to control cash flow.

The first step in managing cash is to construct a 13-week cash flow forecast to help identify risks and actions that can be taken to reduce them. It should include income from sales and other receipts and outgoings, both to ongoing obligations such as rent wages and finance and to creditors.

The business also needs to control cash on a daily basis, with payments made on a priority basis with purchases approved by an authorised person who is aware of their impact on cash flow. This will avoid the risk of returned cheques. It is also advisable to talk to the bank and keep it aware of what is being done to keep things under control.

If the forecast is showing that there is a mismatch in the timing of money coming in and fixed amounts that have to be paid out (such as leases for buildings and equipment, wages and supplies) the cash flow forecast will show where the problems are and suggest what needs to be tackled and the order in which to do so.

For example, a business may have long-standing customers who are themselves facing difficulties and for the sake of retaining their business may have been allowed extra time to pay invoices. However, if this is beginning to push the business towards insolvency action is needed.  It may be that an arrangement can be made with the customers to pay outstanding invoices in small amounts over an agreed period, which will keep at least some cash coming in and preserve the relationship with the customer.

In the same way, the company must manage payments against receipts by prioritising them and paying out of cash received in order of priority. Priority payments will be needed to keep the business going such as purchasing materials where suppliers are often on stop.

The level of intensive cash management will depend on how severe the cash flow situation is.  Steps should be taken to improve cash flow by looking at prices, staffing, overheads and all other costs to consider whether there are cost savings that can be made.  Does the company really need three fork lift trucks or can it manage with two or even one, for example.  Is it possible to renegotiate payments and prices with suppliers or reduce the quantity of supplies ordered? It is in their interests to negotiate since they too will want to survive and retain business. It may be that they will accept a rearrangement of, say, quarterly payments to monthly payments to keep things under control.

Similarly, are all the staff fully occupied? If not, and they are valuable people the business does not want to lose, it may be worth cutting overtime or negotiating reduced hours or reduced wages. If people feel included in the decision making and are all working together to help the company survive agreements can be reached that will help the cash flow situation in the immediate future while also protecting the longer term future.

Tight control of cash coupled with a thorough look at the business model and a realistic business plan will go a long way to help a business survive in difficult trading conditions.