Most businesses that fail in the first five years do so because they run out of cash!
Often still profitable, the business owner has usually lost sight of the important principal that “cash is king”, instead adhering to the principal that growth is good.
As a business grows their cash requirements grow, more money is tied up in stock and debtors, less money is available for paying creditors, wages and overheads.
In a simple world the business collects the cash from their customers before they pay for the stock they sell.
In a business where they have rapid stock turns and they carefully manage their stock with a good understanding of their customers future needs they may only need to fund the gap between paying for the stock and receiving payment.
In the real world it is much more complicated. In the worst case they might buy materials – often paying for it in full or partially before it arrives, then they process them and add value – paying wages and overheads as they go, finally selling the product, to find they wait 50-60 days for payment. A cash cycle of 200 days between paying for the goods and receiving funds from the sale common.
Each step can impact significantly on cash reserves, and need to be carefully monitored.
Unfortunately many business owners continue to run their business by guesswork.
A growing business needs a cash forecast – and needs to use it to manage their business. As we saw in the recession businesses with large stock holdings are at a higher risk when there is a sudden downturn, delays in clearing stock impact quickly on cash.
Fortunately for business owners the cost of systems to manage their business has reduced significantly with the advent of subscription software. Products like Xero mean there is no excuse for not understanding how your business is performing. There are even Xero add-ons to help you collect your debtors. Quality stock management systems are now affordable, and enable businesses to see which stock is clearing slowly, then take action to move it along.