How to effectively plan your cash flow?

Nearly nine out of ten bankruptcies are due to cash flow shortages. This issue affects both struggling businesses and those that are perfectly profitable. How can you guard against it? Three experts share their insights.

How to effectively plan your cash flow?

Rising debt costs, poor management of raw material inventories, and delays in invoice payments are just a few factors that can lead to a cash flow shortage in a company. In some cases, this deficit can even jeopardize the organization's survival. "Many companies send their invoices late and fail to fully leverage their cash flow potential, which causes immediate liquidity issues," explains Andreas Schweizer, head of the MAS Corporate Finance program at the Zurich University of Applied Sciences (ZHAW).

Since no company is immune to late payments, it's worth reconsidering the practice of invoicing only after the service is provided. "This approach essentially means extending credit to a customer or business partner that the company may not know well. It is often better to require advance payment for at least part of the agreed amount," explains Thomas Rautenstrauch, professor of accounting and corporate finance at the Eastern Switzerland University of Applied Sciences in St. Gallen (OST).

In Switzerland, this practice is not very common and can impact a company's competitiveness. "One solution is to offer a discount to clients who pay in advance or settle their invoice shortly after the service is provided," suggests Thomas Rautenstrauch. Requesting partial payment in advance or within a shorter timeframe than the usual 30 days also helps gauge the reliability of a new client. "If the initial payment isn't made on time, you should anticipate further delays and adjust your cash flow management accordingly," advises Andreas Schweizer.

Varying cash flow calculations

A company's cash flow can be calculated in various ways, each significantly impacting the actual results. "The current ratio includes inventories and receivables, but it doesn't account for the company's ability to sell its inventories or collect its receivables," explains Thomas Rautenstrauch. Therefore, relying on the quick ratio, which considers only liquid assets and short-term liabilities is often wiser.

External obligations are not the only expenses a company must cover. In the service sector, payroll often represents the largest expenditure. In industries like manufacturing and construction, it can account for up to a third of costs. "Theoretically, the quick ratio for companies in the secondary sector should be at least 100%. However, since payroll is not included in this calculation, the ratio should ideally be around 130% to 140%. This ratio is even more crucial for service companies," says Jürg Rösti, professor at the School of Management Fribourg.

Furthermore, it is better to entrust accounting management to professionals employed within the company. "Someone with an understanding of the company's core business will better comprehend its cash flow operations than an external consultant and will be more capable of anticipating cash flow fluctuations," notes Thomas Rautenstrauch.

Limiting expenses when cash flow dries up

If inventory continues to increase or the quick ratio declines, the company must act swiftly to avoid the imminent risk of bankruptcy. The top priority is to prevent cash outflows. Thomas Rautenstrauch advises, "Non-essential expenses, such as business trips or continuing education, should be excluded."

Other expenses should also be adjusted. "For instance, attempt to renegotiate the rent for the company’s premises or arrange staggered payments with suppliers," adds Jürg Rösti from the School of Management Fribourg. "If raw material prices rise, reducing production quantities can also help limit cash outflows."

Securing a bank loan

Provided they meet certain criteria, profitable SMEs with cash flow problems can rely on obtaining a bank loan. "Companies must demonstrate profitability, provide collateral, maintain a good credit history, and present a robust business model. Generally, banks are willing to grant short-term loans, especially if companies can show that the funds will resolve short-term liquidity issues and lead to sustainable long-term operations," emphasizes Thomas Rautenstrauch.


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Digital accounting tools

Banana, Bexio, Tresio – many accounting and cash management software tools have emerged in recent years. However, these tools do not eliminate the need for active and attentive cash management. "These solutions can create a false sense of security. Before relying on them for cash management, it is better to first automate certain processes such as invoicing. This frees up human and financial resources for important tasks like accounting," notes Andreas Schweizer, head of the MAS Corporate Finance program at the Zurich University of Applied Sciences (ZHAW).

Last modification 05.06.2024

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