Expert Talk: How to manage cash flow more efficiently? (Part 2)

From your perspective, why is it crucial for owners of SMEs to study cash flow management? What are the possible problems that they could encounter if there’s no cash flow planning?

Cash flow and profit are two different financial parameters. In the long run, when a business makes a profit, it usually results in a similar cash inflow, however, the difference lies in timing. For example, when a seller accepts a 30-day deferred payment from his customer, an accrued revenue is recorded. It is called accrual accounting. As the money is yet to be collected, you can see that the revenue and cash inflow are not aligned. On the other hand, when a company pays its suppliers for imported goods, this cash outflow is not considered to be an expense until they start selling those products. High profits but low levels of cash, which is quite a common occurrence for SMEs, results in a profitable business being unable to pay its bills.

To illustrate this matter, let’s take a look at a simple example: A business whose sales are growing rapidly and profits keep doubling on the previous month. Profit margin is at 40% of revenue, presenting a highly positive scenario.

Nevertheless, as the company allows customers to delay payment within 30 days, it generates negative cash flow.

   
When experiencing a shortage in cash, more established enterprises have more of an advantage than SMEs in mobilising capital. Limited access to financing prevents SMEs from growth and expansion. In the above case, if there is no funding to back up inadequate cash flow, your business could be on course for failure.

Here are two main causes that lead to a small enterprise becoming “cash-poor”:

• Poor sales which leads to insufficient revenue to cover expenses.
• ▪ Profitable businesses that cannot keep track of their own cash flow. Without careful planning and transparent processes to manage finances internally, a company can face problems in controlling cash flow, collecting payments, excess inventory, etc.

Many SMEs concentrate on profit before and after taxes. Peter Drucker, often described as “The man who invented management”, once said: “Entrepreneurs believe that profit is what matters most in a new enterprise. But profit is secondary. Cash flow matters most.” Cash flow is the life-blood of a company and without it, your business will fail. A generous cash reserve can help a company go through a cash shortfall for an extended period of time, however, most SMEs do not have the capacity to deal with that situation and end up filing for bankruptcy.

Consequently, it is essential for a business owner to understand cash flow along with how to plan and operate financial management. Under the assistance of a well-planned cash flow set up, it is painless to manage/ control cash inflows and outflows and easier to prepare capital injections in advance when running out of cash.

 
What do SMEs need to know in order to build an adequate cash management plan?

As discussed above, an inability to monitor cash flow is the biggest issue in small enterprises. The key to effective financial management is to establish a budget and cash flow forecast. No matter what scale your business is, preparing a financial plan is a necessity. For SMEs, it is fundamental to make an annual budget plan in which you can foresee monthly revenue and expenses. Starting from that, you can have an overall projection of monthly incomings and outgoings of cash. While budgeting can foretell profitability, cash flow forecasting helps define net cash flow, which enables us to develop funding proposals in preparation for cash shortfalls. Every business needs a cash “bedding” to secure its financial health during unstable times as well as to utilise strategic investments or cost reduction opportunities.

 
Getting loans refers to financial leverage. Besides providing working capital, a loan can propel the business forward in terms of profitability. Also, interest expenses are tax deductible. Regardless of those benefits, many studies in the domestic and foreign markets show that a large number of SMEs in Vietnam do not ever intend to raise funds through a bank loan. According to a World Bank survey of 996 Vietnamese enterprises, conducted from 2014 to 2016, access to financing is considered as the toughest barrier for businesses – only 28.8% of interviewed enterprises were making use of banking credits. The result also unveils the reason why a great deal of enterprises don’t seek financing from banks is that they find loans highly risky. It means SME owners are not aware of the benefits of utilising financial support from banks. In my opinion, we need to change this misconception so small businesses can thrive. Unless this prejudice is eliminated, SMEs will not be able to expand their operation since depending on internal assets or profits only holds your business back.

(to be continued)

Coming up next in this exclusive series, our discussion with Ms. Hoang Anh will cover why you should consider seeking capital assistance from banks and how to avoid risks. Should you have any question related to this topic or that you would like to be ad-dressed by Ms. Hoang Anh, please leave a comment below. Our UOB experts will get in touch at the earliest opportunity.