MANY companies focus on growing sales and profits to build a strong track record, but don't realise the peril that a seemingly healthy, profitable business can also go bust in a short period of time.
Strong revenues and earnings, and yet ending wound up - isn't this an irony?
Not really if one bears in mind that financial performance is not measured just by the income statement (also referred to as the profit and loss statement) and the balance sheet.
Equally important, but often overlooked, is the cash flow statement.
The biggest bugbear for companies - including the profitable ones - is poor and negative cash flows. Not taking heed of the early warning signs is to invite disaster.
According to Gregory Michael Trotter, head, cash management, OCBC Bank, small and medium enterprises (SMEs) need to manage the cash flow to grow their businesses as it allows them to plan and prioritise their business requirements.
"Effective cash flow management typically involves optimising their payables and collections. SMEs need to have a clear understanding of their payables and expenses in order to prioritise payments based on their respective criticality and their own account balances. This could be in terms of timing, importance to the business cycle or cost of late payments," he said.
The later an SME makes a payment without impacting their own business flow and supplier relationship, the better their cash flow.
Mr Trotter said that collecting payment from customers is more difficult because SMEs do not generally have control of when a payment will be received. Therefore, they need to have a mechanism to clearly track due dates and follow up with customers to remind them that payments are due.
Providing their customers with flexibility in terms of the payment form will help them to receive funds faster as well.
According to Mervyn Koh, managing director and country head, Business Banking Singapore, UOB, companies should not only ensure that cash flow is well managed, but should also optimise the way a business uses cash.
Mr Koh lists three ways in which businesses can do so. The first echoes Mr Trotter's view, which is to speed up the accounts receivable process.
"Many small businesses focus on business development activities over matters such as issuing invoices. However, by doing so, businesses end up slowing down the accounts receivable process which then adds pressure on their cash flow," Mr Koh said.
To make the invoicing process seamless, businesses can consider adopting a digital solution to automate the invoicing process. This method will also help to drive business performance by increasing productivity and reducing manual processing errors, in addition to cost savings.
The second way companies can manage their cash flow effectively is to get a real-time view of cash flow so that they don't need to spend a lot of time doing up their cash flow statement every time it is needed.
The third way is to establish a line of credit upfront.
"Most businesses tend to think of credit as something that you only apply for when a particular issue or opportunity arises, such as to purchase new equipment. Having a line of credit enables businesses to not only manage their day-to-day operations but more importantly, to seize opportunities as and when they arise," Mr Koh said.
Small businesses have several options to meet their funding needs such as working capital loans to trade financing, and he recommends seeking professional advice, either from government bodies or banking partners.
Still, Mr Trotter said that some businesses, especially smaller companies, may have the perception that cash flow management requires complex tools and knowledge, and come at a hefty cost when in fact, there are many simple, convenient and affordable tools available that can help businesses to better monitor and manage their cash flow.
So, which aspect of cash flow do both parties think is most important?
Both Mr Trotter and Mr Koh said that businesses need to manage their cash flow from operating activities such as production, sales, product delivery and the collection of customer payments as it is the main indicator of a business’ health.
"With a clear understanding of the company’s operating cash flow, business owners will then be able to ascertain if they have excess funds for investments or if they need to seek external financing to keep operations running smoothly," Mr Koh said.
Mr Trotter thinks that SMEs looking to expand their business will need to consider the opportunities and costs of funding the expansion through operating cash flows or borrowings (cash flow from financing activities).
"While the latter will come at a financial cost to the SME, there could be times where an opportunity cannot be immediately met by the SME’s operating cash flow. By taking out a loan, the SME could be able to act on the opportunity and not miss out. They will then need to ensure that they can meet the loan repayments from their operating cash flows as this then becomes another payable they will have to meet," he said.
Have more tips to add other than the ones above? Join in the discussion on our previous Just Ask question here.