Identifying cash blockages
Understanding the WCC is the first step in making sure your business has a good strategy around cash flow, particularly WIP (Work in Progress), Inventory and debtors – which is where cash blockages commonly occur.
And it doesn’t have to be complicated to know where to look for these blockages. Effectively the process is that you start off with cash in the bank, sell something (time or product), send someone an invoice, and then they pay you. So if things aren’t flowing quite right, then it is somewhere in that cycle that things are going wrong. Perhaps you aren’t sending out invoices fast enough, you’re letting debtors build up without chasing them for payment, or you’re holding onto dead inventory that is costing you money. Whatever the reason, pinpointing where things are holding up your cash flow is imperative.
Know your balance sheet
It is also recommended that you get to know your balance sheet – what is it telling you? Your profit and loss statement says you’re making money, and your balance sheet tells you what you are doing with that profit. Keep on top of WIP/Inventory and debtors with robust controls, negotiate suitable repayment terms with creditors, monitor throughput and remember – dead inventory is cash not available to keep the WCC going.
Anticipating potential cash blockages
Now, instead of having to respond to cash blockages when they occur, there are ways to foresee potential issues, and you and your accountant should be monitoring these areas on a regular basis. The first step is to use the working capital ratio.
This ratio can tell you what your average debtors number is and how many days your debt has been sitting there. You should monitor over time the number of days debt is accruing for, and ideally you want this to go down, but in some cases if your sales are going up, then it is okay for debtors to go up too – marginally. If their ratio goes up too high then it slows the WCC down, resulting in a cash blockage. The bottom line is: how much have you got in the bank?
Ideally, as you are running the day-to-day functions of your company, a good accountant will be able to keep on top of these critical cash flow indicators, and communicate any issues to you in a proactive manner. So there should be regular reviews of your business, assistance with preparation of a cash flow projection and analysis of original projections that is then updated for actual YTD figures – resulting in an effect of cash flow going forward based on those updates.
Any decent sized business should always have a cash flow prediction – how much do we have now and how much in 12 months, 24 months and 36 months? Then there needs to be continual updates of those actuals going forward so you can make changes and continually monitor your balance sheet, as this will always assist in dealing with cash flow blockages if they occur – so you can respond quickly and effectively to reduce the impact on your business.
Your accountant should be working with you on a regular basis to discuss reasons why the cash flow predictions weren’t accurate and how you need to plan going forward. Maybe the first three months of the year weren’t very good and you’ve got less money in the bank – so why is that? Is it tied up in inventory or debtors, is your profit not as much as it should be, do you need to go back to the profit and loss statement to see if estimations were a bit optimistic.
It is always about ‘what are the numbers telling us’, and hopefully your business accountant is available to analyse all of those things, however, we would always recommend you have solid knowledge of how to read a balance sheet, and understand profit and loss and the WCC – so that you can make the right decisions for your business.