What’s the best way to anticipate cash shortages and deal with them?
How to solve cash flow problems, but before they happen
All businesses at one time or another will experience cash shortages to a lesser or greater degree. But what’s the best way to anticipate cash shortages and deal with them before they become a problem. Let’s take a closer look…
What’s the best way to anticipate cash shortages and deal with them in 15 seconds…
The best way to anticipate cash shortages and to deal with them quickly is to have a good accounting and management reporting system in place. A good accounting and management reporting system should help you to focus on key performance indicators like cash at bank and in hand; Customer debts or trade debtor days; Time taken to invoice customers; Inventory or stock turnover ratios; Gross profit margins; Net profit margins; and Supplier payment days.
What’s the best way to anticipate cash shortages?
The best way to anticipate cash shortages, but to be able to deal with them quickly, is to have a good accounting and management reporting system in place. But in addition to having good and up to date management accounts, it’s also key to prepare regular cash flow forecasts too.
A good accounting and management reporting system should help you to focus on the following key performance indicators:
- Cash at bank and in hand.
- Customer debts or trade debtor days.
- Time taken to invoice customers.
- Inventory or stock turnover ratios.
- Gross profit margins.
- Net profit margins.
- Supplier payment days.
Let’s now take a closer look at each of these key performance indicators (KPIs) in more detail.
1. Cash at bank and in hand
Possibly one of the best indicators of cash flow problems and to help anticipate cash shortages is to keep an eye on cash and bank balances.
This may seem an obvious answer, but is still worth mentioning in any event. Monitoring cash balances during each month to watch for major fluctuations or to keep a look out for a general trend of an increase or a decrease in cash balances is a will help you to anticipate cash flow shortages before they happen.
2. Customer debts or trade debtor days
The second KPI to monitor is your businesses debtor days. If you debtor days begin to rise, there’s a problem brewing. This could mean your credit control department are not doing there job properly, or it may point to other external factors. This could include a problem with your customers and their ability to meet their own debts as they fall due.
Monitoring your debtor days on a regular basis will allow you to spot any trends and to correct it before it’s too late. Either find out what the problem is in the credit control or speak with any customers who appear to be having difficulties. If it’s the latter, you may need to stop selling to these customers or at the very least limit the amount of credit they receive.
3. Time taken to invoice customers
For any business to thrive and grow it’s important to invoice customers as soon as possible. The longer you take to invoice customers, the slower you’ll receive payment for the invoices.
This key performance indicator will allow you to monitor how quickly invoices are being raised and by keeping this under management, you’ll be able to spot problems well in advance and make sure the problem is corrected as soon as possible.
4. Inventory or stock turnover ratios
Another important KPI for monitoring cash flow and working capital is to keep a watchful eye on inventory or stock turnover ratios. It’s important to set realistic stock turnover levels for each stock item. You don;t want to be carrying too much stock for too long.
If your stock turnover ratio begins to slow down, this could indicate a problem. But by monitoring this ratio or KPI you will be able to spot this and act on it quickly. It might be you have an automatic re-ordering system, but that may not be linked to stock levels. If this is the case, but an item’s sales begins to slow, the inventory of this time will begin to rise.
This will cause you to tie up more cash in your stock than is needed.
5. Gross profit margins
Your gross profit margins are an important key performance indicator to monitor. If your gross profit margin begins to fall, this could indicate a problem. It could mean your business is becoming less efficient, it could indicate that your supplies are becoming more expensive.
But whatever the problem, if your gross profit margins are falling, this will not only reduce your business profits, but it will also begin to impact on cash balances. By monitoring your gross profit margin on a monthly basis will allow you to react quickly to changes, but it will also help you to anticipate potential cash flow shortages too.
6. Net profit margins
Your net profit margin is another important KPI to monitor. Similar to your gross profit margin, you need to keep a close eye on this, as any reductions in your net profit margin might indicate an impending cash flow blip.
7. Supplier payment days
Most businesses are provided with credit from their suppliers, it’s a part of normal business practice. But it’s important to monitor your supplier credit days. If this begins to reduce, it could either mean your suppliers are pushing harder for payment earlier, or it could indicate your accounts department are paying suppliers too soon.
Either way, by monitoring this KPI, you will be able to catch any changes early to anticipate any problems down the line with cash balances.
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