Business mentor: Conquering those cashflow crises

Q: I have a small business which is going from strength to strength. Sales are sky-rocketing and we are very busy, but we are constantly running short of cash. Why is cashflow still a problem even though our sales have increased significantly? How can I turn this around?

* Tracey McKeown, director of Urban Accounting, replies:

A: There are a number of potential explanations why increased sales might not equate to increased cashflow. The main areas to review are:

* Cost of sales (margins).

* Expenses or overheads.

* Fixed assets.

* Credit.

Cost of sales are the costs directly attributable to providing the product or service the business is selling - in a cafe or restaurant these would be the ingredients and beverages.

Keep an eye on wastage, which results in your cost of sales being higher than they need to be.

Keep an eye on inventory levels. Inventory equals money invested. If you hold high levels of stock, this is money spent that you have not yet had a return on. Consider buying smaller volumes of slow-moving items or negotiating a sale-or-return policy with your suppliers.

Watch your sales margin (sales less cost of sales). If your margin is reducing or varies markedly it could mean:

* You should review pricing of new products.

* Cost of sales may be increasing.

* The balance between products with different margins has shifted.

Learning how to measure your margin will help you understand your business better and provides you with a tool to measure how effective your pricing is.

Expenses or overheads are the day-to-day costs of running your business. Things to consider are:

* Understand the difference between fixed and variable costs. Some costs are incurred no matter what level of sales you have and do not vary with the level of sales. These are fixed costs such as rent and the cost of administration staff. To calculate the level of sales required to cover off these expenses, total up the fixed expenses and divide by your sales margin. This will give you the amount in dollars you will need to sell in order to cover your fixed expenses.

* Getting the best price. When you started out in business you may not have been in a position to get a volume or business rate for some of your expenses such as stationery or printing. Now your volumes have increased it may be worth reviewing your pricing options.

Fixed assets are items you buy for the long term such as computers or manufacturing equipment, and are often significant enough to have a major impact on cashflow. Consider leasing and financing options if cashflow is an issue.

Credit affects your cashflow. If there is a significant difference between the credit terms you offer clients and those you are receiving from your suppliers, you have a potential cashflow problem. For example, if your clients pay you on the 20th of the month and your suppliers require payment within seven days you are paying out money for sales that have not yet been collected.

Here are some ways to tackle this problem:

* Talk to your clients about changing payment terms. You may need to provide them with an incentive such as a discount.

* Introduce credit limits to minimise your exposure so that if clients place a large order, it will not destroy your cashflow for the month.

* Ask your clients if they would consider paying you by credit card at time of sale, thereby preserving the terms on which the clients are paying but allowing you to get your money faster.

* Talk to your suppliers about moving to monthly payment terms.

* Ask your suppliers if they will accept credit card payment, which will increase your effective payment terms.

* Always invoice your clients on time.

* Consider putting a cashflow forecasting process in place. This allows you to predict and be prepared for cash shortages.

* Tracey McKeown can be contacted by e-mail or ph (09) 376-2701

Email your small business questions to Georgina Bond. Answers supplied by small business sector specialist Sarah Trotman.