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Ahead of The Adviser’s Bootcamp SME Broker 2017, Duncan Russell reveals how understanding the seven cash drivers in a business can give brokers a competitive advantage.
One of the top three reasons for business failure is insufficient capital.
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For any SME owner, keeping a close eye on the seven cash drivers in the business helps them understand exactly how much working capital is required to succeed.
For brokers, gaining a solid understanding of all seven, and how they work together, allows them to have meaningful conversations with their small business clients about appropriate working capital management.
The best working capital financiers will partner with brokers to help uncover cash conversion cycle issues within their clients, and present funding solutions that are purpose-fit for that client’s cash conversion cycle.
The cash conversion cycle covers from the first day you spend a dollar to when you receive a dollar for your product. Understanding this cycle helps a business to accurately estimate their funding requirements. Armed with this knowledge, the business can adapt these seven cash drivers to make that funding period (from spending a dollar to making a dollar) to be as short as possible.
Our workshop at The Adviser Bootcamp SME Broker 2017 will cover how the seven cash drivers impact any SME’s cash conversion cycle.
The seven cash drives are:
- Sales – Most businesses monitor sales, understanding that in order to increase sales, a business first needs to spend cash on costs, including product development, raw materials, advertising and employees. Sometimes, selling more can create cash flow headaches, because the business has to fund that sale, often well before the customer pays.
- Price – Increasing or decreasing the price of goods is a direct cash influencer. Monitoring margins helps you spot quickly if profit margins are reducing, and act accordingly.
- Cost of Goods Sold – Negotiating or restructuring the cost of your goods — for example, buying in bulk or reducing waste — can have real cash impact.
- Overheads – Whether fixed or variable, overheads are sunk costs. These monthly expenses may be for the same items (such as electricity or wages) but can vary from month to month, so they require monitoring of actual versus budget to keep a handle on operating costs.
- Accounts Payable Terms – If you are paying suppliers faster than customers are paying you, it can cause a squeeze on cash. The longer you can negotiate, the better the use of your cash.
- Accounts Receivable Terms – The shorter the number of days it takes customers to pay, the better the use of your cash. If debtors are increasing more rapidly than sales, and your credit terms remain the same, you could be facing a serious cash flow problem.
- Stock/Inventory Holds – Keeping track of the cost of holding stock helps you monitor potential overstocking, or buying stock that is not selling.
These seven variables are ones any business owner can monitor and adapt to control the availability or use of cash in their business. Controlling this process can be the difference between business success and disaster.
Australian small businesses typically might closely monitor only one of the drivers: sales. The ones that really should be tracked, as they have the maximum impact, are the Accounts Receivable Terms, Accounts Payable Terms, and the Stock/Inventory days. SMEs run the risk of financial troubles if these are not closely monitored.
While you may think your business is making a good profit margin, until you analyse all seven cash drivers, you cannot measure your margin accurately.
For example, if your cash-to-cash cycle is 60 days, then the funding cost for that 60 days needs to be considered in order to arrive at an accurate return on the product.
The cash drivers work independently of each other, and getting them working together will provide maximum benefit.
Once brokers understand this process, they are more prepared for informed conversations with clients and potential clients about any funding gap, and what their options are to adequately fund the business.
Brokers with this knowledge will be able to apply it to potential clients who are growth businesses, considering MBO and M&A activity, under financier or creditor pressure or looking to refinance their property.
Duncan Russell is general manager (Victoria) for Scottish Pacific Business Finance, Australia’s largest independent working capital specialist. Duncan, and his fellow state general managers at Scottish Pacific, will be presenting a working capital workshop to help brokers master the seven cash drivers and identify funding opportunities at The Adviser Bootcamp SME Broker 2017.
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