Business Base

In this current economic climate, battening down the hatches - cutting all but the most essential of expenditure, reducing headcount, postponing capital expenditure and delaying payments to suppliers - may seem like the obvious thing to do. But rather than just "slashing and burning", a methodical approach to cash management will be much more effective in ensuring the business can weather the storm whilst still protecting its ongoing ability to create value.

There are four elements to sound cashflow management, and these are outlined below:

1. Aligning and Planning your Cash Resource

Be very clear about which projects and activities will contribute most to delivering the business strategy. Adopt a disciplined approach to focus on the core business and divert cash from non-core activities to support these areas. Now is an excellent time to consider which customers, products and channels are the most profitable and to review planned projects and investments. Are there projects that should be deferred until the economic outlook becomes clearer, and are those investments critical to the business or should they be stopped or delayed? Tough decisions will be required to successfully manage businesses through this downturn. 

Proper Cash planning differs from the day-to-day monitoring of anticipated cash movements, looking at the next 8~12 weeks with a view to keeping within the overdraft limit. Planning your cash resource starts by identifying where cash is currently employed within the business (eg working capital, operational costs, loan repayment & financing charges). Then define what cash is needed to fund the business-critical activities and projects. Finally, create a plan of action, reducing or removing the cash employed or earmarked for non-core activities and strengthening investment in core areas. This process will highlight any overall cash shortfall, and give the business an opportunity to address this proactively rather than waiting for the problem to manifest itself down the line.

A recent example of this single-minded approach is Honda Motor's decision to withdraw from the high profile and prestigious Formula 1 racing circuit. Rather than reduce investment, perhaps at the expense of weaker performance, they took the difficult decision to withdraw completely so that they can redeploy the cash to support core activities.

2. Eliminating Cash Waste

Cash waste is defined as any cash consumed by the business which is not supporting activities necessary to deliver the business strategy. Reviewing and optimising working capital, looking at innovative ways to reduce supply-chain and logistics costs, bargaining hard and asking for cash discounts from suppliers for early settlement of account, enhancing controls over purchasing and order processes (core and non-core) by lowering authorisation limits and introducing greater senior management accountability - leave no stone unturned when looking for and eliminating cash waste.

For many businesses, employment costs represent the biggest cost heading (after raw materials within manufacturing companies). Whilst there may be a compelling case to make redundancies, it must be recognised that there can be significant short-term costs associated with this, and losing skilled employees may damage the company's ability to take advantage when market conditions do improve. Now is the time to examine alternatives such as altered working patterns, banked hours schemes and flexible working arrangements so that you can match capacity with customer demand without increasing costs. Whilst there may have been resistance to such proposals in the past, employees are likely to be much more receptive to change in today's economic climate.

3. Understand Cash Break-Even

Don't be fooled into thinking that everything is rosy because the P&L says so. Cash is King, and it is the Cash Break-Even point that we need to know for our business. Cash Break-Even is the point at which the business is trading at a cash-neutral level. It is generating sufficient cash through trading activities to cover all recurring cash liabilities, including those that do not go through the P&L.

This differs from traditional break-even analysis in as much as it recognises the business needs to generate sufficient cash to cover operating costs and non-P&L cash items such as loan repayments and the capital element of finance lease payments. Its purpose is not to replace the detailed cash monitoring that recognises movements in debtors, creditors and stock; rather it highlights the minimum ongoing level of monthly sales required to ensure the cumulative cash position is not deteriorating.

A simple example of a cash break-even analysis is shown below.

This calculation shows that to be cash neutral, this business must be generating sales of £1,215K each month before it will generate additional cash to invest in the business. By knowing this figure, the management can look at different scenarios and identify what cost base can be supported by the business at different operating levels. If the business cannot generate a cash surplus based on expected levels of trade, it will be necessary to find cash savings.

This calculation is also a simple way of evaluating the impact of additional investment, by looking at what additional level of sales will be required to improve the cash break-even point. It is a simple approach, but can be a very powerful tool to check how well positioned your business is to weather the economic storm.

4. Reviewing Existing Sources of Finance

Since the onset of the credit crunch, there are fewer sources of finance and those that still exist can be expensive. Banks are looking at viability as much as liability when considering which businesses to support. Having a clear business plan and highlighting how cash is to be used in protecting and strengthening the business will help to secure the funding needed and to negotiate favourable rates. In addition to this, it is worth looking in detail at the funding structure within your business. For example, if your business has a well run sales invoice system, you make sales on credit terms and you don't raise sale or return or stage payments against contracts, then Confidential Invoice Discounting (CID) may be an excellent source of finance without the stigma often associated with factoring.

Summary

The need to carefully manage cash has never been greater. However, it is important to strike a balance between protecting the cash asset and starving the business of investment. With careful planning, a rigorous approach to cutting out waste and a focus on the business critical activities, your business could well emerge from the downturn in much stronger shape.