The importance of cash flow managementEvery successful entrepreneur understands that cash flow is the lifeblood of their business, and that without it, the business will not survive. In the current economic environment, effective cash flow management is crucial for any business to stay afloat. Cash flow provides the necessary funds for day-to-day operations and helps protect the business against unexpected expenses.
When discussing business cash flow, entrepreneurs and subject matter experts often refer to working capital. Working capital refers to the funding available for a business to carry out its daily operations. This funding can come from the business itself or from external sources such as banks.
Analyzing the working capital cycle is an effective tool for determining a business's working capital needs. The working capital cycle measures the time it takes for a business to turn its net current assets into cash flow. By reducing the working capital cycle, a business can increase its cash flow by improving the efficiency with which it utilizes its current assets and liabilities. This can be achieved by reducing the time taken to collect debtor payments through offering settlement discounts or extending the terms offered by creditors.
Another tool available to entrepreneurs is conducting a detailed assessment of their business's expense lines to identify areas where the outflow of funds can be limited. By implementing measures to achieve this, a business can redirect funds to areas where they are most needed, such as salaries or taking advantage of supplier settlement discounts. The following are examples of expense lines and activities that should be scrutinized as they result in funds leaving the business without generating returns:
Rental of premises – Placing a deposit with the landlord as security for non-payment of rent and property damage.
Electricity expense – Placing a deposit with the regional electricity provider or municipality as security for non-payment of monthly electricity bills.
Inventory expenses – Placing a deposit with suppliers as security for non-payment of trading accounts.
An efficient solution to these scenarios is to use a guarantee issued by a financial institution, such as a bank or insurance company. By issuing a guarantee, the deposit with the landlord or supplier can be replaced, allowing the business to utilize the deposit more efficiently. Depending on the credit position of the business, the deposit can either be invested in an interest-bearing account as security for the guarantee or used as cash flow relief if other assets are available as security.
Placing funds in an interest-bearing account enables the business to earn a return on the deposit that exceeds the inflation rate, generating real growth. If the landlord or supplier relationship is long-term, issuing a guarantee allows the business to benefit significantly from the compound interest effect. This effect is the concept of earning interest upon interest over time, resulting in a substantially higher balance. As Albert Einstein famously said, "compound interest is the eighth wonder of the world." This principle motivates many investors to deposit funds into interest-bearing accounts for extended periods.
As the global business environment continues to evolve, entrepreneurs need to ensure they have sufficient cash flow to not only survive unexpected challenges but also seize growth opportunities. By effectively managing cash flow and utilizing innovative solutions like guarantees, businesses can achieve superior growth rates compared to their competitors and potentially explore new markets they hadn't considered before.
* Tomas Iindji is the Head of Business Banking and Clusters at FNB Commercial.