Cash flow is defined as the movement of cash or cash equivalent, in and out of business for trading. The quantity and availability of cash flow can affect the quality and size of deals that a company can attract and convert into profit for its shareholders. As per a recent study, around 82% of small businesses fail due to inappropriate cash flow.
Rotimatics, a company that recently went through a financial turmoil, is a perfect example of business failure due to mismanagement in cash flow. The company burnt more money (almost five times more) than it could raise.
Importance of a Positive Cash Flow
Positive cash flow means that the company is growing and producing value for the people associated with it. It also indicates that the company has been able to build its liquid assets, pay off debts, maintain a healthy profit and loss statement, and plan its future. Positive cash flow pays salaries to the employees, bills to the authorities, and taxes to the government. Whereas, negative cash flow is the indicator of a company’s failures in keeping up with the business trends, customer expectations, or a change in the economic ecosystem.
The uncertainty associated with the positive cash flow is a financial barrier faced by every organization. However, when put in an SME’s context, the problems that can arise due to the absence of a healthy cash flow seem to multiply by several folds. Therefore, the importance of maintaining (at the least) decent cash flow is a priority for an SME.
Challenges of Cash Flow Faced by an SME
SMEs or startups need high liquidity to churn out profit day after day. Although finance departments of the companies ensure that the businesses have enough cash flowing in and out of the system, a cash crunch never rings the bell before showing up. There can be several reasons leading to such a situation. Still, a recent study by SPRING Singapore indicated that delay in receiving payment from the clients is the biggest cash flow challenge faced by SMEs in Singapore.
As per a study conducted by Plum Consulting, late payments have adverse effects on SMEs. Not only the SMEs lose a lot of their productive hours chasing debts, but they also fail to pay their suppliers on time and face reduced liquidity for investment. The study shows more than 16% of the invoices raised by SMEs in Singapore go past their due date, and out of these, close to half are written off as bad debts.
SMEs that indulge in long term projects are also susceptible to cash crunch if they are unable to source advance payments. As a result, SMEs have to invest their own money into the projects and wait for client permissions. In case the approvals take time, SMEs can lose opportunities due to the absence of liquid assets to reinvest in the business.
Similarly, SMEs that are involved in the manufacturing sector may have to cut down on the production if they do not have enough assets to source raw material or pay for labor. Reduced production will eventually lead to lower profit, lower productivity, and inefficient use of funds.
On average, Singaporean SMEs take almost 15 days more than the expected time in collecting the funds, which is much more than some of the strong economies of the world like Australia, France, and Canada. The graph below shows the number of extra days taken by SMEs of different countries in getting the payments done.
How Does Late Payment Impact Cash Flow?
SMEs aim to strike a perfect balance between incoming payments and outgoing payments to have a good cash flow. However, this is tricky and almost impossible because businesses have to pay for investments, services, taxes, fees, loan repayments, interests, and whatnot at a definite interval. Also, payments received from customers are not periodic, and not in sync with the company’s expenses. Therefore, to maintain the sanity of the business, the company should know when to expect the payment.
When the payments get delayed, the company can go berserk; and can be forced to take drastic measures to keep the operations afloat. It can land the company in a pool of severe debt and turn the positive cash flow into a negative one.
How to Analyze Cash Flow?
If you have an accountant doing the books, you should ask for a cash flow report at the end of the week or the month to check your situation. In case, the accounting is done personally, the easiest way to find out the cash flow situation, look at the difference between the amount payable to the supplier, against the amount receivable from the clients during the same period. If the amount of money flowing in is more than the money going out, then one has a positive cash flow. Else, will be looking at negative cash flow and, possibly, much financial trouble.
Also, while analyzing the cash flow, make sure that one should only count income and expenses that have happened. Future projections, revenues, and liabilities do not form a part of cash flow calculations. Sometimes, negative cash flow can be due to an investment made during the period. As a business, one should focus on creating an overall positive cash flow.
Small businesses that are undergoing expansion can witness a negative cash flow for several months due to the high expenditure on acquiring man, material, and machine. However, this is usually set off by a high volume of high-quality assets flowing into the organization by investors
Steps to Manage Cash Flow
The first step towards managing the cash flow is to identify the factors that lead to it. It will help the SMEs in reducing the cases of late payment. As per a survey, the payees shared the following reasons for late payments:
- Not receiving the invoice on time
- Disputed invoice amount
- Waiting to pay the invoice on a future date
- Seller taking a long time to process invoice
- No reasons given
3 out of 6 reasons given by payees get eradicated if the SMEs focus on creating accurate invoices and expediting the process of resolving disputes on errors in the invoices. Apart from improving the invoicing process, the SMEs should implement the following suggestions to save themselves from a cash crunch.
Anticipate the tools and investments that get made in the future
If the SMEs are foreseeing a big purchase in the future, then they need to start planning today. A small business has a hard time absorbing a sudden financial shock. BUT, if they are prepared, making a big purchase can turn into a profitable proposition.
Get lenders in confidence
Start building connections with people who can lend the SMEs money when a need arises. Banks and commercial lenders are least interested in giving loans to businesses that are struggling with the cash flow. However, personal connections can help them survive a terrible phase at manageable interest rates if they have a good rapport with lenders.
Singapore has several P2B and P2P platforms that enable individuals to give loans to businesses based on their affinity in the community. For example, when a startup called We The People needed funds quickly for their expansion operations, they were able to source money from Funding Societies, a peer-to-peer financing platform based on their credibility and rapport in the community.
SMEs to make themselves lucrative to banks
While banks may not be ready to give instant loans to SMEs, but if they can produce creditworthy assets, banks will be happy to deal with them during the bad times. Here are a few options that the SMEs can explore with the banks:
- AR Line of Credit: AR or Account Receivables is a method of maintaining and showcasing the money coming in from the customers. These reports can help secure a business loan in line with a defined AR-Loan ratio depending on the money flowing in the AR accounts. When the AR increases, the banks issue the business a more significant line of credit, and when AR decreases, the banks expect the money to be paid back to maintain the ratio.
- Inventory of finished goods is another right way to source secured loans from banks. Once stocks get sold and the amount will recover, banks have no problem issuing loans to the businesses against a defined level of inventory. However, banks may not shy away from releasing a loan against a catalog of unfinished goods. Also, owned equipment in good condition can help a business in securing a short-term loan. DBS offers a fantastic solution to companies looking for an Inventory Financing Loan.
Work with the vendors
Quick payments to vendors can hurt SMEs cash outflow. Therefore, they need establish a more extended payment cycle with the vendors. Doing so will buy them enough time to collect payments from customers and pay to vendors on time. Usually, vendors do not have any problem in agreeing to a 60-day payment cycle. This period will give the SMEs enough time to follow up with their customers and get paid. However, they need to make sure that the payments to vendors don’t get delayed to a point where they would be liable to pay interest on the debt.
Government Support to SMEs
Late payment is an issue faced by several SMEs in Singapore. Therefore, to help the businesses outlive the challenges, the Government of Singapore has devised a few programs and policies aimed at reducing the burden on SMEs. Here is how SMEs can benefit:
Capital Development Grant
Capital Development Grant helps SMEs in building capabilities in various genres of operations like branding, marketing, process productivity, business model transformation, intellectual property rights, financial management, standard adoption, business excellence, product development, and service excellence. The grant gets managed by Enterprise Singapore and can be used to wade up to 70% of the project cost.
SME Working Capital Loan
SME Working Capital Loan aims to provide an unsecured loan of up to S$300,000. The loan was started keeping in mind the sudden cash crunch that companies of the SME sector can face. The money from the loan can be used to meet working capital and cash flow needs.
SME Micro Loan
Companies that are just beginning their operations in Singapore can apply for the SME Micro Loan. The loan offers S$100,000 in liquid cash that can be used to carry out day to day operations and cash flow. The loan can also be used by small companies to upgrade factories and equipment.
Invoice discounting is the method of obtaining working capital by securing a loan on invoices that get paid in the future. While the invoice paid as collateral, it does not enable or force the lender in managing receivables for the business. The lender gets a discount fee when the invoice is paid, thus ending the loan transaction.
To conclude, for an SME, cash is the lifeline of the business. An inadequate cash flow can force the company to take unwanted measures to save itself. However, with a little planning and knowledge, SMEs can manage their finances efficiently and maintain positive cash flow. Also, the government understands the problem with delayed payments and, therefore, has formulated programs to help SMEs stay afloat. One can check the official website for the eligibility criteria of various grants and loans aimed at SMEs in Singapore.