Ask A Financial Expert
Ask A Financial Expert
(FranchiseCanada, July/August 2003)
Q: Our franchise is doing well. Sales are growing and profits are rising, but we also seem to be going through cash faster than ever. Should we worry?
A: It’s good to worry about these things. Most franchisees are focused on sales: the more, the better. But, it can be a fatal mistake to think higher sales and profits equals success.
Business survival depends on the ability to pay bills and loans. And, you can’t use profits to do that. You need cash. Some of the fastest growing companies are those that most frequently experience cash flow problems. Profits can quickly get tied up in inventory, equipment and accounts receivable, which are areas that may not convert easily into cash when you need it.
How do you avoid a cash crunch? You need to establish good cash management habits that track and balance spending and collections. Once you get into a proper cash management routine, it becomes easy to maintain. The benefits? You acquire a clear understanding of your franchise’s cash flow cycle, are able to meet financial obligations, identify troublesome spending patterns, maximize opportunities fro business growth and reduce the risk of fatal surprises.
Good cash management habits require examining your current practices and looking for ways to improve cash flow.
Prepare a cash flow forecast
A cash flow forecast is an estimate of the amounts and timing of projected cash inflows and outflows for a defined period of time. Forecasting enables you to plan for the amount of cash your business requires at different times throughout the year. Most businesses produce monthly (or weekly for those with cash-dependent franchises) forecasts for a period of a year.
Prepare monthly cash flow statements
A cash flow statement tracks daily use of cash over a four-week period, providing a picture of revenue-generating activities and capital requirements. The statement measures net cash flow from three areas of the business, which are operations, investments and financing that require or generate cash.
Every month, review the results captured on your cash flow statement and compare them with your forecast. This will enable you to see the cumulative effect of cash flows and to flag problems before they become serious. You can then take specific steps to speed up the inflow or to slow down the outflow of cash.
1) Implement formal credit practices
Establish formal credit and collection policies, including:
- Completed credit applications requiring completed credit applications from all new customers;
- Credit checks on each potential customer;
- Specific credit limits for every customer; and,
- Review credit limits for any problems or changes.
2) Accelerate accounts receivable
The goal for your accounts receivable system should be to accelerate the inflow of cash. The longer it takes to collect receivables, the more likely they are to turn into bad debts. Moreover, past-due receivables tie up working capital and restrict business growth.
Invoice immediately;
- Issue account statements on a monthly basis;
- Monitor accounts receivable every month to identify potential problem accounts as early as possible;
- Act on overdue accounts immediately: contact by mail or phone, charge interest, stop shipment or appoint a collection agency;
- Determine the average age of your receivables (receivables/sales x 365) to measure the effectiveness of your collections procedures; and,
- Look for opportunities to accelerate receipts, by, for example, offering discounts for early payment.
3) Manage accounts payable
Accounts payable can serve as a valuable source of short-term financing for your business when you manage them effectively.
- Determine the average age of your payables (payables/sales x 365). Compare this with the average age of receivables to determine whether cash inflows/outflows are in tune;
- Look for opportunities to negotiate extended terms or discounts with suppliers;
- Review accounts payable monthly to identify any burgeoning problems;
- Do not pay suppliers any earlier than required under negotiated payment terms neither should you be late with payments or you may jeopardize your credit terms;
- Reconcile supplier statements with invoices to ensure you don’t make a common mistake: double payments; and,
- Reconcile monthly bank statements.
4) Optimize inventory
Effective inventory management involves balancing the advantages and burdens of inventory to achieve optimal profitability. You want to maintain customer service while minimizing the costs of warehousing.
- Maintain lean inventories: set realistic targets and re-ordering systems;
- Measure inventory turnover (days required to turn over a specified inventory) to provide a benchmark against which you can determine sales rate fluctuations, this will help you identify any sudden or serious sales slumps;
- Compare your inventory turnover with industry averages to measure how well your business is doing with inventory management; and,
- Discount or return outdated or slow-moving inventory.
5) Minimize expenditures
Expenses have a tendency to inch ever higher. You need to keep an eye on spending to ensure every expense is contributing directly to your business.
- Measure and monitor the ratio of costs to sales as major changes can signal an impending cash flow problem; review expenses at least every quarter and weed out non-essentials – those without a demonstrated return. Common money eaters are payroll, rent, car leases, expense accounts and share-holder draws;
- Link variable expenses to revenue. When revenue falls, ensure these expenses also fall;
- Compare your costs with those of industry averages to see where your business falls into or out of line; and,
- Before adding any new expense, assess whether it is essential. Will it directly benefit your business?
6) Review fixed assets
Your fixed assets such as land, buildings and equipment should provide you with a good return on your investment. Carefully manage your overhead and minimize any unnecessary expenditure.
- Keep fixed costs as lean as possible;
- Review assets to determine what you could reduce or eliminate without impacting your products, services or customer service;
- Consider leasing rather than buying to conserve cash; and,
- Lease or sell obsolete or underutilized equipment.
Get into good cash management habits today. Knowing at all times where your cash is going means knowing exactly where your business is heading.
Rick Chittley-Young, B Comm, CGA, is a principal of BDO Dunwoody LLP (www.bdo.ca), one of Canada’s leading accounting firms, which helps entrepreneurs succeed. Rick, who is located in the Oakville office, helps franchisees and franchisors launch and expand their businesses. If you have questions about this article or would like to receive BDO’s “Tax Factor” newsletter, contact Rick at tel: 905-884-3206, fax: 905-844-7513, e-mail: rchittley@bdo.ca, or 151 Randall Street, Oakville L6J 1P5.
