Managing a cash flow crisis
19 February 2016
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Chris Gibbons: Welcome once again to Old Mutual Live Business. Our topic in this podcast, cash flow, why it’s so important and how to manage a cash flow crisis. Our special guest, an expert in this very field, especially as it pertains to small business, Pavlo Phitidis, CEO of Aurik Business Incubator. Pavlo, hello and welcome. First off, let’s define what we mean by cash flow?
What is meant by cash flow
Pavlo Phitidis: You know Chris, the best way to think of cash flow as an entrepreneur is to understand yourself and your body because cash flow is really like the blood in the body. Without the blood in the body, the body can’t function, you can’t get enough oxygen to the right areas of the body. You become sluggish, you struggle to move and you eventually perish.
Cash flow is really the movement of money, the stuff that makes business happen through the business itself, firstly in how you pay your suppliers, how you match that to your customers who pay you and then finally; to how you settle the bills on a monthly basis, such as staff and rent and technology.
CG: Accounts talks about assets and liabilities on a balance sheet, profit and loss on an income statement and even, hopefully at some stage in the future, dividends for shareholders, but it’s cash that pays the bills.
Money in the till pays the bills
PP: It is cash that pays the bills and you know, a set of accounts doesn’t talk to cash flow. For example, there is something called going broke. If you’re building a business in a particular manner in a particular industry and you can generate tremendous revenues, which look fantastic on an income statement; you can find yourself broke three, four, five months later if you haven’t managed the cash flow. Cash flow is really matching when money comes in, when money goes out and the people that are best at this are typically traders.
You know when you walk into that store and in the old days when people smoked, you would see them working on the back of the cigarette box, figuring out how much cash they’re making in the day. How much cash they’re spending in the day and that is the best example that everyone should hold onto because it’s the money in the till. At the end of the day, that counts and that’s what cash flow is.
CG: Let’s labour the point, if I may, let’s be clear. Cash flow is not the same thing as profit?
PP: It’s certainly not the same thing as profit because in the derivation of profit, you’re using accounting terms. You have things like, for example, depreciation, which is not a cash flow item. You might have goodwill amortization, you might have sales recorded and invoiced, but the money hasn’t come into the bank yet. Because, in fact, all you’ve done is created a debtor.
You might have creditors or suppliers, but you might not have paid them yet. So, profit is a derivation of accounting principles. Turnover and revenue, as well, cash flow in, cash flow out is certainly not, it’s not part of the accounting equation.
CG: What then are the basics? How do I make sure that the cash flows properly?
The trick to keeping cash flowing
PP: So, the first starting point Chris, and this is such a struggle for all entrepreneurs; in fact 99% of entrepreneurs that I’ve met, including myself. I never started my business to build an accounting back office, a data capturing back office.
When you start in the very early days, the first one or two transactions, three or four or five transactions are very easy to keep up with. You get a sense of the money being spent, you get a sense of the money being made, the difference is the positive or negative cash flow.
As a business grows, things become more complex and in that complexity, especially once you start registering for VAT, for example, you need to start keeping accurate data and accurate accounts. That means that you need to have, what I refer to as a back office.
A place, a space where you have an individual, ideally not yourself because it’s a very emotional matter working with money when you’re the business owner; but you have an individual who is capturing the receipts, who’s making the payments, who’s settling all your compliance requirements such as tax and VAT and keeping accurate data. If you don’t have accurate data, as to how much money is either being made, or very often, being lost, you won’t find yourself in business much longer.
CG: Now, many businesses, and you’ve alluded to this already, but especially small ones, seem to be doing well enough, but suddenly they find themselves facing a cash squeeze, what are the warning signs?
Warning signs of cash issues
PP: The warning signs are if you have done your costings incorrectly. People get very confused between let’s say gross profit and mark up percentages. That means that you need to have a good understanding of data because if you don’t know how to calculate your costs, you are going to get your profit figures wrong. If you get your profit figures wrong, you’re going to get the business wrong.
The second thing is, if you don’t have a proper, accurate record of all the expenses running through your business, then it puts you in a position where you won’t understand when your break-even point is arriving or moving away. That break-even point is an important feature. A break-even point is the point in which the cash coming into the business meets the cash going out the business. In other words, you’re breaking even.
The intention must be to build a business where your fixed costs, the costs that you have to spend, every single day, every single month, to keep the business alive, are lower than the money coming in. It sounds obvious, but it gets very tricky if you don’t have accurate data.
CG: In your experience Pavlo, do businesses track those symptoms leading to a cash flow crisis early enough?
PP: No, they don’t. It normally takes a cash flow crisis for you to get accurate data put in place. It’s a funny thing, we as entrepreneurs are really no good, really no good at being told what to do. We mostly have to do it, learn from the experience and then adapt and change.
Going back to it, one of the features of a good entrepreneur is an individual who doesn’t repeat the same mistake again and again. I think most of us will go through a period when we experience a cash flow crunch. Where we experience cash flow trauma and on the back of that, the remedy to that, to prevent it again, is to go back to your back office. Make sure you’ve got accurate data and once you’ve got the accurate data Chris, you’ve got to develop a relationship with that data. You need to understand what it means.
CG: Okay, so now we have a fully blown cash flow crisis, the overdraft is being used up, the bank manager’s not speaking to us, debtors aren’t paying, creditors are clamouring for their money, help Pavlo, what do I do?
Full blown cash crisis! What to do
PP: Sell the business for a rand or alternatively, alternatively, there are a couple of things that you need to do. The first thing is, and I think it’s an important message for all of us to consider going into this new world that we’re facing with the current rand/dollar, low growth environment. That is that you’ve got two types of expenses that go through your business.
You’ve got variable expenses. A variable expense, Chris, is the expense, it goes up and down with sales, as sales go up and down. Then you’ve got fixed expenses. Fixed expenses are those expenses that don’t change. For example, if you have rented a premises and you’ve rented the premises for R15 000 a month, every month, irrespective of your sales, you have a R15 000 fixed overhead.
I think a key to adapting and creating a business that will survive and thrive in this tough economy, is to start looking, what fixed expenses do I have and how can I make them variable expenses. So they only come about when sales come into the business. It will reduce your profit margin, but it will increase the ability of the business to run through some shockwaves that I think we’re going to expect this year.
The second thing you need to do Chris is you must invoice fast. When you’re conducting business, invoice fast. If you don’t have a proper accounting system; one that is attached to your cellphone, one that is attached immediately to your bank account, one wherein which you can invoice on the go, wherever you might be. Through your cellphone, for example, instead of having to wait a day or two or three, then get with the technology. It’s cheaper to operate and it allows you to keep cash flow on hand far quicker.
Then the third feature is going to be those people who owe you money, go and do deals. Go and do the deals to get the money, and as fast as possible. People who owe you money, that you keep on supplying will, needless to say, you’re going to find yourself in even worse trouble.
CG: So, when do I know, in the middle of this crisis Pavlo, when do I know that I’m turning the corner or alternatively, when do I know that it’s time to pull the plug?
PP: That’s where we get back to what we spoke about earlier, the breakeven point. If you move your fixed overheads into variable overheads, you’re going to bring down your breakeven point. In other words, you would need less cash flow in order to keep and sustain the business.
If you don’t know what that fixed overhead structure looks like and you can’t calculate your breakeven point, then you’re never going to know whether you’re winning or losing this particular race.
CG: More sound advice there from Pavlo Phitidis, CEO of Aurik Business Incubator.