Cash flow is one of the most, if not the most, crucial elements that drive or derails any business in any situation and time. Cash flow becomes critical during uncertain and volatile times. While systemic (external; market-related) and unsystematic (internal; industry or company-specific) risks prevail in any conditions, uncertain situations like a pandemic, recessions, war, natural calamities etc throw up new and volatile challenges.
Fundamentals of cash flow
Before we dive into the nuances of cash flow management, we need to take a look at some fundamentals of financial statements – profit and loss, balance sheet, and cash flow statement.
Taking a cue from the phrase ‘revenue is vanity, profit is sanity, cash is reality,’ we realise that revenue is the top line and does not give a good view about the performance or health of the company. On the other hand, profit is a residual figure at the bottom line after deducting expenses from the amount in the top line, which is revenue.
However, all profit is not cash as profit considers non-cash expenses like depreciation and amortisation, invoices raised but cash not collected, inventory yet to be monetised, supplies received in inventory but not paid, and even projects in progress but not invoiced and collected. Cash on your balance sheet is the amount of actual cash you have after paying your expenses and liabilities from the cash collected and received.
There are three categories of cash flows –
- Cash Flow from Operating Activities: It is almost equivalent to working capital or cash activities related to revenue and expenses accounted in profit and loss account to calculate profit.
- Cash Flow from Investing Activities: It relates to cash movement in non-current assets, or in other words, capex.
- Cash Flow from Financing Activities: It includes funds received through investments, capital raised in the market through IPO, FPO, debt financing through debentures, loans or in other words activities related to cash movements in non-current liabilities.
For the purpose of this article, when we say cash flow, it implies that from operating activities, except in rare instances.
The basics of managing cash flow
Some elements are critical to cash flow management, specific to situations, industries, segments, and companies.
Manage receivables, efficiently
Managing receivable, or in other words – the process of collecting payments from your customers, is arguably the topmost element in supply chain cash flow management, whether it be of the companies in manufacturing or service or tech business.
Even if you may not be aggressive enough to chase payments with your top customers in normal times considering the good customer relations, you don’t have the luxury to be passive when it comes to collections as your customers may also not be in a position to pay in time during abnormal times, such as now.
To safeguard from the risk of delay in payments, companies often resort to offering cash discounts or demanding customer to open a letter of credit or pay in advance. These options are not always feasible as difficult times apply to you and as well your customers in the supply chain.
Some of the other options you may use to manage your receivables are factoring – a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount, or discounting invoices – the practice of using a company’s unpaid accounts receivable as collateral for a loan provided by a finance company. Credit control policies can also help bring in aggressiveness in the collection though SMEs may not always have that kind of luxury.
You need to proactively assess the risks involved in the receivable collection and have mitigation plans in place or your payments to suppliers will default which may lead to disruptions in supply due to non-payment of supplier invoices.
Manage payables, intelligently
One way to preserve working capital is to delay payment to your suppliers. Some companies may unilaterally decide to do so and such an approach is likely to damage your supplier relationships. Even worse, it might deprive supply chain partners of the cash they need to maintain their operations, which could lead to late deliveries and quality problems that, in turn, would disrupt your operations.
Ideally, you should work with suppliers to establish an agreement that both of you can live with. There might even be situations where you need to accelerate payments to a critical supplier to maintain the integrity of your supply chain and prevent a critical disruption. You need to factor in such eventualities too in your cash management plan.
Cash-to-cash conversion cycle
Under normal business conditions, companies primarily focus on profit and losses–growing the top line or driving growth, while managing the bottom line. In an abnormal situation like the ongoing COVID-19 pandemic, smart companies are shifting their focus from profit and loss to the balance sheet.
There is a tendency among companies to focus more on inventory than the other elements of supply chain working capital–payables and receivables. But, to minimise working capital requirements during challenging times, it’s important to apply a coordinated or comprehensive approach that addresses inventory, receivables, and payables that make up the cash-to-cash cycle.
Revisit your variable costs
You can reduce your cash outflows than focusing on controlling your fixed costs in a much quicker way by reducing your variable costs. Fixed costs are mostly sunk costs and cannot be retracted. Variable cost includes raw materials, a certain portion of labour cost, and some overhead expenses.
Reduction in variable cost can be achieved through negotiation of prices with suppliers, putting a hiring freeze, placing restrictions on discretionary spendings like entertainment and training, and controlling other variable overheads after evaluating their implications on the business. Automation of repetitive processes, tasks and jobs are other routes that are being looked at to reduce labour cost in manufacturing, services, and tech businesses.
However, it may be noted that job cutting is not an end in itself and should only be resorted to judiciously.
Reconsider capital investment plans
With cash flow forecasts in mind, you have to consider which capital investments aka capex is really necessary immediately or for the near future, what capex can be postponed until the situation improves, reconsidered or rationed. Also, what capital investments are required to position for the rebound and for creating competitive advantage?
That said, you should not sacrifice your growth plans due to a paucity of funds. You should either generate sufficient cash internally or get external funds to fund your growth plans if it cannot be postponed, else your growth journey may get dented.
Management of inventory is crucial
Manufacturing companies are at risk of experiencing supply chain disruptions due to shortages in raw material and components during difficult times like now. On one hand, companies will be increasing the buffer stock to take care of the possibility of supply chain disruptions or potential uncertainty of the uninterrupted supplies, and on the other hand, they may be looking at reducing the finished goods inventory because of slack in demand to free the cash stuck in inventory.
Balancing the demands for more buffer raw material inventory, inventory level to be maintained for finished goods for uncertain market conditions, and managing cash flow all simultaneously may not be as easy as it sounds. However, many companies are likely to find that significant cuts in inventory levels harm customer service and production. Informed decisions are key in such situations.
While there is no raw material or finished good inventories in services and tech companies, they have cash stuck in projects in progress but not yet billed and collected, the resources they have on the bench, and as well the resources getting added to the bench for the paucity of orders.
Keep eye open for alternate revenue streams
If your primary products or services are facing a demand downturn, consider ways you could temporarily or maybe even permanently replace that revenue stream. For example, if your primary markets used to be international, you need to track how you might pivot to domestic markets, and how you could think differently about how those assets can be leveraged to generate alternate revenue sources?
We have seen in recent times that many companies have started using their manufacturing facilities and assets with changes, if and wherever needed, to produce articles and medical devices that have been in demand specifically for the protection of COVID-19. For example, in brick and mortar stores going online or hybrid mode or services aggregators adding cashless payment options or food delivery etc. In other words, challenges have opened up opportunities for certain businesses.
Convert fixed to variable costs
Think of meeting your needs through opex, which were earlier met by capital investments. In times of uncertainty, it’s generally a good idea to swap fixed costs for variable costs wherever you can. Selling assets and then leasing them back is one way to raise emergency cash. You might also want to consider expanding your use of practices such as contract manufacturing, transportation fleet leasing, back-office services outsourcing, and third-party warehousing.
Almost all kinds of services and assets are in the process of moving to subscription as a service mode, making them opex. This is not likely a quick-hit measure for most companies, particularly SMEs, but may be important to longer-term cash flow management.
The availability of proper data and information at right time is important. In uncertain times, this is of paramount urgency. You should know who has not paid your invoices in time, how long they have been outstanding, who are the top defaulters, which critical suppliers are not paid in time, or which suppliers may stop supplies by resorting to credit control measures.
Equally important, if not more, are questions as to which critical raw materials and consumables are at critical inventory levels, which items might need revision of buffer stock levels, which are fast-moving and slow-moving finished goods, which category of manpower resources are moving to the bench, who can fill the resource categories that are in more demand, which products generate high margin per unit and capacity, and many such valuable information and data useful for decision-making.
Don’t take cash flow lightly
Cash flow management needs to be an integral element of a company’s overall uncertainly risk assessment and action planning. Even for companies that have not yet been adversely affected, it is recommended that management teams from all functions with concerns about challenges like COVID-19 actively evaluate their cash flow requirements, and develop appropriate actions under various scenarios.
SMEs are probably the most affected and the ones that have to navigate through the troubled times than large enterprises that are cash-rich and/or have easier access to funds. MSMEs in India has protection from delayed payments, access to collateral-free loans and rebate in interest rates etc, based on the applicable criteria, under various MSME schemes of the government. MSMEs should keep updated on such benefits and schemes, and avail of them when eligible and in need.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)