How not to get caught in a cash crunch
Canadian Business Franchise Directory
Published Sep 2004
Many of us may be getting lulled into a false sense of security. Most sectors of the Canadian economy have been humming along for the past few years. But now is not the time to get complacent about the health of your franchise. A cash crisis can erupt very suddenly – and just as suddenly mark the demise of a business. One major customer that defaults on payments. The breakdown of one vital piece of equipment. One particularly slow sales season. Any could cause a cash crunch and any could cripple – or close -- your franchise… unless, that is, you’re prepared for a crisis.
You will be prepared when you know when, where, and how your cash needs will occur and you have sources in place to meet any additional cash needs in the event a crunch does occur. Here’s how to get prepared.
Use cash flow forecasts
Cash flow forecasts are your most powerful cash management tool. They can help you to develop the right financial strategies to meet the needs of your franchise under a variety of conditions.
A cash flow forecast estimates the amounts and timing of cash you expect to flow in and out of the business for one month, or, in the case of cash-dependent franchises, each week. Typically, you would prepare forecasts to cover a one-year period.
These forecasts enable you to:
- determine where your franchise stands now—and where it’s going;
- budget the cash needs of the business over a period of time;
- anticipate slow cash periods and establish appropriate cash flow strategies;
- maximize the advantages of discounts and specials;
- plan for equipment purchases;
- prepare for adequate and appropriate future financing; and
- demonstrate to lenders your ability to plan and to repay loans.
The level of detail you will require in your cash flow projections will vary depending on the complexity of your business. Best to ask your accountant to suggest a software program that will work effectively for your particular franchise.
Review cash flow on a regular basis
All franchisees need to know where your cash is going at all times. A cash flow statement will provide you with a picture of revenue sources and cash requirements by tracking your business’s daily use of cash over a four-week period. This statement integrates cash flow from three sources:
- operating -- also known as working capital, is generated from internal operations;
- investing -- generated internally from non-operating activities such as investments in equipment or other fixed assets; and
- financing -- generated by external sources, such as loan repayments to an investor.
Your accountant can suggest a software program that you can use to prepare appropriate cash flow statements. Then, get into the habit of preparing and reviewing these statements at least every month – weekly if you have a cash-dependent business.
Compare the results on your cash flow statements with your forecasts. This will enable you to see the cumulative effect of cash flows and to identify any problems before they become serious.
Following are some strategies that you might want to consider to ensure your franchise is in good shape to cope with any potential financial challenges.
Accelerate Accounts Receivable
- Invoice daily.
- Negotiate longer-term contracts with customers.
- Offer discounts for early payment.
- Monitor accounts receivable monthly to identify potential problems.
- Calculate the average age of your receivables (receivables/sales x 365).
- Issue monthly account statements.
- Act on overdue accounts immediately.
- Stop selling to chronically slow-paying customers.
Monitor Accounts Payable
- Calculate the average age of payables (payables/sales x 365); compare this with the average age of receivables to determine whether cash inflows/outflows are in tune.
- Negotiate extended payment terms or discounts with suppliers, particularly if your franchise has seasonal fluctuations.
- Review accounts payable monthly to identify potential problems.
- Schedule payments to your best advantage: don’t pay suppliers earlier than required under negotiated terms and utilize worthwhile early payment discounts.
- Reconcile supplier statements with invoices to ensure you don’t double pay.
- Reconcile monthly bank statements to confirm inflow and outflow of cash.
- Establish a track record for paying on time so that creditors will be willing to work with you during a crunch.
Control Spending
- During slow periods, minimize the funds you draw for personal use.
- Measure and monitor the ratio of costs to sales; major changes may signal an impending cash flow problem.
- Review expenses every quarter; eliminate those that cannot demonstrate a return.
- Link variable expenses to revenue; when revenue falls, reduce these expenses.
- Compare costs with industry averages to assess where your franchise is on or off target.
- Before adding any new expense, assess whether it will directly benefit your business.
- Sell any assets that you can eliminate without impacting your products, services or customer service.
- If necessary, conserve cash by leasing rather than buying.
- Lease or sell obsolete or underutilized equipment.
Keep Inventory Lean
- Measure inventory turnover (days required to turn over a specified inventory) monthly to identify any sudden or serious sales slumps.
- Compare your inventory turnover with industry averages to assess your inventory management success.
- Discount or return outdated or slow-moving inventory.
Anticipate Future Financing Needs
- Reduce your debt load where possible.
- Establish a rainy day fund; put money into an interest-bearing account that you can draw upon in an emergency.
- Negotiate an overdraft option with your financial institution.
- Line up prospects for additional financing in the event of a future cash squeeze.
- Monitor your debt-to-equity ratio; ideally, it should be in the range of 1:1 -- if it’s approaching 3:1, it’s time to take action.
Remember, a cash crunch can cripple or kill a franchise. You cannot prevent a financial crisis, but if you're prepared, you can survive – and maybe even thrive.
Rick Chittley-Young, CGA, is a principal of BDO Dunwoody LLP (www.bdo.ca). BDO is one of Canada’s leading accounting and advisory firms, which helps entrepreneurs, family businesses, franchisors and franchisees succeed. If you have questions about this article or would like to receive BDO’s “Tax Factor” newsletter, contact Rick in the Oakville office at (905) 844-3206 or rchittley@bdo.ca.
