Cash flow is the money that moves in and out of a business. Cash flow moves both ways:
a) Into a business from your customers who buy your products or services
b) Out of a business to pay suppliers, operating, and financing expenses.
If more cash is flowing into the business than out of the business, the business is in a "cash flow positive" state. If more cash is flowing out of the business, the business is in a "cash flow negative" state, and the owners of the business will have to find additional funds to meet their obligations.
Cash vs Receivables
Unless your business collects cash from your customers upon the completion of the transaction, a sale does not mean that the cash is in your account.
For example, if your business sells on 60 days credit terms, this means the cash is only received 60 days later.
Unfortunately, your monthly expenses, such as salaries and bills are payable monthly. Therefore, your business is unable to depend on the sale to pay your suppliers or expenses until 60 days later.
If there is not enough cash in your bank account to meet your obligations for the month, your business will have to seek external funds to finance your cash flow.
Most SMEs prefer to sell to large corporates due to their better credit rating and larger purchasing power. However, these large corporates will usually have a policy of buying on credit terms.
Cash vs Payables
Most businesses have 2 types of payables:
- Operating expenses
- Trade payables
Operating expenses are the monthly obligations that a business has. Examples of such expenses are salaries, CPF contributions, utility bills and finance expenses. These expenses are due monthly, and need to be met in order to keep a business going.
Trade payables are payments to your suppliers for goods and services that are consumed by a business in order to generate revenue. The longer a business takes to pay its suppliers, the more cash the business holds. However, due to their lack of bargaining power and track record, most SMEs are unable to negotiate for longer payment terms with their suppliers. In addition, if you continuously pay your suppliers late, it will affect your relationships with your suppliers.
Net Profit Does Not Mean Cash Flow Positive
From the example below, we can see that as a result of a preference to sell to large corporates, and a lack of bargaining power to negotiate for payment terms, most SMEs face a cash flow gap created by its trade practices.
Example
SME makes 60 days credit sale of $1,200, and has to pay suppliers $400 and monthly expenses of $200.
| Period | Total Expenses | Revenue In |
|---|---|---|
| Month 1 | -$400 | $0 |
| Month 2 | -$200 | $0 |
| Month 3 | -$200 | $1200 |
From the net profit perspective, the company will have recorded a net profit of $200 from the above example.
From the cash flow perspective, the SME has to meet its expenses of $1,000 for month 1 and 2 and 3 before receiving payment in month 3. If the SME waits until month 3 to pay their expenses, the suppliers might have taken legal action to recover the debt, and their staff might have stopped working, leading to business failure.
It is no wonder that according to an Enterprise Singapore survey, 64% of SMEs currently face some form of delay in receiving payments from customers. In fact, delayed payments were ranked as the top finance-related challenge they expect to face. Delayed payments can have a serious impact on an SME's cash flow and working capital management if not managed carefully.
Strategies to Improve Cash Flow
In light of the above, what can SMEs do to improve their cash flow and their chances of survival?
Below are some strategies that B.Smart have implemented for our clients:
1) Receivables Finance
SMEs can sell their invoices due to a funder in exchange for cash upfront to plug the cash flow gap. Funders usually disburse up to 80% of the invoice value, and are repaid when your customer pays you. It is important to know the actual time your customers take to pay you.
(Tip: If your credit terms to your customers are 30 days but your customers regularly pay in 45 days, your business actual credit terms are 45 days).
2) Supplier Finance
SMEs can get additional credit terms by using a supply chain financing arrangement. This helps businesses preserve cash and extend their payment terms to suppliers without affecting supplier relationships.