Month: November 2018

Cash is king, long live the king

Start up business live and die by cash flow. This is especially true for start-up small businesses. As your business grows and more and more income start to flow through your business it can be tempting to relax a bit and think that the pressure is off and you can now pay yourself a bit more, lease a better car or office etc. This can be a symptom of a common fatal mistake for business owners – mistaking income growth for profit.

Once you move past the early knife edge stage of starting up your SME, it is critical that SME owners and top managers understand that future growth will depend on paying close, I would go so far as to say extreme attention, to cash management. In particular the first three years are critical. According to The Australian Bureau of Statistics 42% of all small business fail in the first three years. Even more alarmingly 92% of small business do not see their 11th anniversary. Why?

One reason is that owners can be deceived by what appears to be success. Even though there is an increase in income many small businesses are often only continually in danger from falling over the cash flow edge, depending on the next pay cycle or their overdraft for their survival, and unable to create a cash buffer/reserve for the inevitable crises that come up in business. Often it will only take one creditor to default or one bout of key person illness to send the business to the wall.

However, for the purposes of this blog entry, I want to be positive and talk about SMEs that have been successful in navigating through the early stage of business start-up and that are starting to see real growth. An example would be a SME that has grown from 1-2 employees to now 6-8 employees, income has quadrupled from the first year and the business now has regular customers and a reputation for good products and/or service depending on the nature of the business. Let’s call this type of business an early growth stage SME. This type of SME business has moved past the start up related growth spurt related to customer interest in a new business.

Early Growth Stage SMEs and Cash

As an early growth stage SME, how focused should you be on cash management. The answer is you should be intensely focused on cash management. There is an old adage in business – turnover is vanity, profit is sanity, but cash is reality. All businesses should be closely monitoring their generation of cash, but this is extra true in the heady days when you realise that you have established a successful small business and not only survived the dangerous early years but have achieved growth. Let’s examine what you should be doing as a successful SME.

What do we mean by cash?

The first need is to have a proper understanding of what cash is to your business. Most people think of cash as cash flow – how much money is coming in to the business and at what time and in what amounts. While this is an important cash indicator it is only one indicator that must be managed in an effective cash management strategy. There are other cash indicators such as cash reserves, assets that can be easily converted in to cash (liquid assets) and credit facilities which are potential sources of cash. Your cash management strategy should be thought as having two equal elements – your cash flow and your cash holdings which is cash on hand (operating cash) and cash reserves.

Your accounting system is NOT a good guide to cash management. Accounting systems are designed to show the state of your business against accounting standards which are in turn focused on compliance requirements. They appear to be a good guide as they include comforting titles such as your Profit and Loss statement and your Balance Sheet. A smart SME owner will realise the limitations of the formal set of accounts e.g. the Profit and Loss Statement.

They are snapshot of the profit and loss of business as at a single day usually 30 June.

They are retrospective not prospective

The P & L ignores several things that you pay for such as asset purchases, debt payments, drawings, inventory, and tax

A smart SME owner should implement both the traditional profit and loss reporting systems in conjunction with a cash flow forecast model, so that all cash flows of the business are taken into consideration.

Why do businesses need cash?

Now you are a growth SME you will need a comprehensive cash strategy that provides

operating cash for day to day needs,

enough cash reserves on hand to sustain the short-term volatility of the business cycle

cash reserves to meet short term and long-term growth objectives.

All the above cash needs are possible to meet by credit e.g. an overdraft. However, this is a very dangerous strategy. A smart SME will have a cash management strategy that is based on a judicious use of a mixture of revenue and credit to generate cash. The exact mix will differ for each business and consider factors such as whether your business is seasonal, known regular expenditures e.g. tax payments, insurance premiums, equipment replacement schedules etc. In a later blog article, I will cover in more detail the factors to consider when deciding to use revenue or credit for cash needs. Before making that decision, you should have a clear idea of what creates cash in your business not counting credit.

Cash flow drivers

The following are the main cash flow drivers:

Revenue – Sales and other income into your business is your revenue. This is the most obvious source of income and revenue growth will drive the business into the future.

Gross profit – i.e. revenue minus cost of goods sold is what sustains a business. Gross profit retained in your business becomes cash and can be used to pay for direct expenses or it can contribute to cash reserves. If gross profit is taken out of the business, it provides a return on investor equity.

Overheads and Expenses – are the costs for operating the business. Reductions in overheads and expenses result in more available cash.

Accounts Receivable and Accounts Payable – accounts receivable refers to the amount that customers owe businesses from sales made on credit. Accounts payable is money business owes to suppliers. To create a good working capital strategy, businesses need to be able to collect their outstanding debts faster than they pay their outstanding creditors. This then also creates cash. If businesses get a tightening in their working capital, it will affect their ability to grow, and could even send a growing business bankrupt, as they are paying quicker than receiving, so eventually they will run out of cash.

Inventory – Inventory should be thought of in the same manner as credit. If you hold too much inventory you will increase expenditure through businesses holding costs, and if you hold too little inventory the business may lose both current and future sales. Like the overall cash strategy, the inventory strategy will be different for each business e.g. a retail business with a physical outlet (shop) will have a different inventory need to an on-line retail business.

Capital expenditure – Capital are expenses you incur to operate the business and to make the business more efficient e.g. through new IT systems. Capital expenditure gets treated differently in formal accounts from operating expenditure. Do not let this deceive you though when planning your cash strategy. Capital expenditure is still an expense like any other and because they are often large (lumpy) expenditures they will often need careful consideration in a cash flow strategy especially if paying for the expenditure from revenue is being considered.

Summary

I’ve discussed with you why cash flow forecasting and management is so important for the survival of family’s and small businesses, and how the lack of cash flow management is one of the major causes of family and business failures.

I’ve discussed why businesses need cash and why it is necessary for families and small businesses to create cash reserves for that eventual rainy day. By families and small businesses creating and increasing a cash buffer/reserve they are moving away from the cash flow edge.

I also discussed the various cash flow drivers and their effects on a business’s cash flow.

For families and business to create enough cash reserves they should start allocating surplus funds, however small in the beginning to a separate bank account that is never accessed, unless called upon for that rainy-day situation. By families and small businesses creating an ever-increasing cash buffer/ reserve they are then moving away from the cash flow edge.
I have also explained that normal accounting is designed for a different purpose that cash flow management. As an SME owner you should obtain professional assistance with the traditional tax and regulatory compliance accounting, but you should also make sure you receive professional advice in the non-compliance areas of business such as cash flow forecasting and management. You may get both forms of advice from your current accountant. However, if you believe that you need specialist cash flow forecasting and management advice, feel free to ring Walker Strategies to discuss your needs.

RECRUITING FOR SUCCESS

Part of becoming a successful small business is ensuring that your employees contribute effectively to the success of your business. This is critical if you are to grow your business beyond the initial start up stage. In the early start up stage for a small business of say 1-5 employees, the business owner is usually a Jack or Jill of all trades. The owner is manager, problem solver, chief doer and primary motivator for the business. As your business grows, the ability of the owner to be all things to all people diminishes and tasks must be delegated. This can be a nervous period for an owner as it can be hard to let go of some of the roles while at the same time there is a realisation that this letting go must happen if growth is to be achieved. This usually means adding employees.

If you want to grow your business, then you must ensure that recruitment is approached in a planned and professional manner. Many SME owners focus their early recruitment efforts on people they know – friends, relatives, or employees from other businesses they deal with. This is often rationalised as good practice because ‘I am dealing with people I trust.’ Or ‘I know they will be loyal’. This is a hit and miss approach if you have not first properly analysed the needs of your business. The early growth stage for an SME is no time to be sentimental or to use guesswork.

The following steps will help make sure that recruitment contributes to the growth and profitability of your business.

1. Make sure you really need a new employee

This sounds obvious, but it is surprising how many owners take a simplistic approach to analysing whether a new employee is needed. You should not recruit a new employee just because all other employees are flat out and you or they want to ease the workload. Points that should be considered are:

What is the work operation that is being addressed through the proposed hiring? Alternatives to hiring should be properly considered before any hiring. Depending on the nature of the business common alternatives are contracting out, automation and other IT based solutions, rearranging existing work procedures, rosters, layout etc.

Is the proposed hiring truly addressing growth or is it a consequence of inefficiency? For example, a badly laid out warehouse or store for a retail business can cause additional workloads through unnecessary movement to pick and pack orders. This inefficiency can make it appear that you need an additional store worker when a redesign of the layout in the warehouse may be a more appropriate solution.

What will be the effect on cash flow when you hire a new employee? An employee is a permanent increase in cost to the business. Employee costs are also regular with the period depending on whether wages are paid weekly, fortnightly or monthly. When calculating the financial impact on your business the true cost should be calculated based on gross wages and on-costs, costs of training and opportunity costs as supervisors and other employees must assist the new employee rather than focusing on their own work.

How long before your business achieves a return on the investment in new employee? If you have done your analysis and you are hiring for growth, then you need to consider the time needed before a new employee contributes effectively to the growth of your business. Some types of positions have inherently longer periods than others before a new employee can be classified as generating a return that is greater than the employee’s cost e.g. recruiting an apprentice, or a new graduate typically involves a longer before the employee is effective. Other positions may also require some time.

All the above questions involve both strategic and financial analysis. The smart SME owner seeking to achieve growth will involve their accountant and business advisor in these questions and avoid ‘flying by the seat of their pants’.

2. Take a structured approach to recruiting new employees.

Once you have decided that recruiting a new employee is appropriate for your business plans, then you need to decide how you will arrange the recruitment process. Just as with the process of deciding if you need a new employee, there are several logical steps you should take when recruiting.

The first and most important step is to make sure you have an up to date Recruitment Policy in place. Having a formalised recruitment process outlined in a policy will not only make the process easier for internal or external recruiters but will also reflect well on your business from the point of view of the candidate. Recruitment policies should establish the process recruitment will take, including why there is the need to fill or create a new position, advertising the role, and selecting the right candidate. Recruitment can be a time-consuming practice and having a policy in place can make it much more time efficient and streamlined process.

Your next step is to create a detailed and well-thought-out job description. This assists recruiters and job seekers and creates efficiency by targeting the right people for the job and reducing enquiries from applicants who are either not interested in or are not aligned to your job requirements. Things to consider when creating a job description include the skill set required by the employee, how much experience is required to fill the position, and the specific expectations of the role?

The third step is to decide how you will inform the job-seeking community of your vacancy? Will you advertise the position or use a recruitment agency? If you advertise what media will you use, print media such as major or local newspapers, association journals etc., or on-line such as SEEK and similar on-line agencies. You should always ensure that your job description is well reflected in advertisements you place to find the right candidates.

On to one last and vital step. What if you have advertised the position and you have some excellent candidates to choose from? What if all their skills and experience match the requirements for the role and you cannot seem to find any reason to choose one over the other? If you are in this situation and have applicant’s that seem to have similar skills and experience you should look to discriminate among further by:

Checking references and past employers including double checking that this has been done by external recruiters.

Asking for a second interview. It is surprising how many times new information is revealed in second interviews.

Closely consider your organisation’s culture and the personality of existing employees and owners. Then think about the applicant’s personalities. You should at last think about a matching personality but in addition an applicant with high motivation and a willingness to show ambition and leadership can have a positive impact on existing employees. If you are recruiting for a sales or supervisory position, then personality and motivation are critical, and you perhaps should consider using an expert recruiter familiar with techniques in recruiting for these types of positions. Remember that while skills and experience are important, personality factors also contribute to success.

3. Comply with your legal obligations

There are many statutory requirements regarding the recruiting process. Some of these requirements apply to all employees such as anti-discrimination requirements. Other requirements apply to all employees covered by the national workplace relations system, however only certain entitlements apply to casual employees. In addition, there can be Award requirements and requirements related to certain classes of employees, for example apprentices and trainees.

Unless you are fully familiar with your legal obligations, it is best that you seek professional advice in advance of commencing the recruitment process. Some sources of advice business advisors, lawyers, industry associations and accountants. A smart SME owner will seek advice beyond the advice on compulsory obligations commonly supplied by lawyers and accountants and seek advice tailored to the needs of their industry and their own business situation. In most situations this will be a business advisor, an accountant or lawyer who is also a business advisor or an industry association especially where workplace relations advice such as Award interpretation is required.

If you have any questions on this article feel free to contact Fred Walker at Walker Strategies.