Planning Your Cash Flow

At Riyad Bank we want to do our best to ensure Saudi businesses flourish and become all they can be. It is why we provide free guidance and recommendations for you to effectively manage your businesses cash flow.

Cash flow is the lifeline for any business that wants to keep its head above the water and increase its profitability. Learning how to manage it effectively, could eliminate many of the usual problems that businesses typically face.

It is generally true that money moves out faster than it comes in, and because it is easy to run short of cash without realizing it, it’s often too late for the owner, the bank, or anyone else to do anything about it.

The stop this from happening there are two key factors that you can analyze and consider:

  • Incoming cash (receipts)
  • Outgoing cash (payments)

To come up with these figures you will have to make a series of assumptions about how your business will be operating. Should your cash outflows be greater than your receipts, then you have an early warning that some action should be taken.

Determining Cash In

Preparation of the cash flow budget begins with a one-year profit and loss (P&L) budget. The P&L budget is a snapshot of what you expect your operation to look like at a given time. It is based on “accrual” accounting.

Revenue is recorded immediately when goods or services are sold and expenses are recorded when they occur. This “accrual” accounting does not reflect when the cash is actually received, or take into consideration when the expenses for the labor and material that went into sales were actually paid out. Only a cash flow budget will allow you to see the crucial effects of timing differences in actual receipts and disbursements of cash.

Therefore, step one is to take your P&L and convert the sales forecasts into cash receipts by month (please refer to the Riyad Bank - SME Toolkit CD ROM, enclosed with this pack).

Determining Cash Out

Generally, there are three forms of cash outflows to consider, although expenses will vary according to the type of business that you operate:

  • Overhead expenses are generally “fixed,” and consequently don’t vary much with the level of sales volume. Usually paid on a monthly basis, overhead expenses include such items as: rent, telephone, salaries, employee deductions and power. Keep in mind that some of these may still change, for instance:
    1. Utility costs can vary with seasons
    2. Holiday close-downs are usually preceded by a double payroll and followed by a partial one the following month
    3. Rent charges may include a percentage of sales for a component
  • Cash outlays for goods and other variable costs are partly determined by sales volume as well as inventory levels and payment terms.

Example: Assume your cost of goods is 50% of your selling price and you have decided to keep a three-month supply of goods on hand.

  • If you were forecasting SAR 200,000 in sales for the first quarter of your fiscal year, you would need SAR100,000 of goods (at cost) in inventory at the start of that quarter. However, this does not describe the outflow of cash to pay for inventory
  • You must consider when the payment for the inventory is actually made. Some of it, such as direct labor in a manufacturing firm, is paid out early. On the other hand, raw materials may be obtained on credit terms ranging from 10 to 90 days or more.
  • Intermittent expenses are important and should not be overlooked in cash outflows. Consider:
    1. Loan payments
    2. Purchase of machinery or equipment
    3. Bid deposits (contracting)
    4. Dividends
    5. Zakat
    6. Insurance premiums
    7. Major selling trips, training programs
    8. Special projects

Preparing the Cash Flow Forecast

The best way to help you prepare your own forecast is by taking you through an example (with the Riyad Bank SME Toolkit) of a completed Cash Flow Budget Planner indicating the three months May to July (In this case, the company is a manufacturer).

For most businesses, a 12-month cash flow budget by month is sufficient. However, for companies with a heavy movement of cash, such as retailers or restaurants, it can be better to budget cash flow by the week, especially for peak seasons.

10 Ways to Help Increase Your Cash Flow

As any small business owner knows, that maintaining smooth cash flow requires juggling nearly every facet of a business, from staying on top of accounts receivable, to extending lines of credit, to managing inventory.

The essence of successful cash flow management is regulating the money flowing in and out of your business. Increasing your cash flow reduces the amount of fixed capital that you need to support the given level of your business. An increased, consistent cash flow also creates a predictable business pattern, making it easier to plan and budget for future growth.

Here are 10 things you can do to increase your cash flow:

1- Organize your billing schedule

The faster your receivables turn over, the more capital you'll be able to spend on growing your business. To help you bill early and often, put yourself on a billing schedule with an accounting software programs, which can automatically classify the age of accounts receivable (fewer than 30 days old, between 30 and 59 days, between 60 and 90 days, etc).

This kind of automated flagging system allows you to act immediately on overdue accounts.

2 - Stretch out your payables

Take the maximum amount of time allotted (often 60 or 90 days) to pay your suppliers. Think of these terms as an interest-free line of credit from your supplier. It gives you sufficient time to collect receivables without spending money on short term credit lines.

3 - Take advantage of early payment incentives

If your suppliers offer you a discount for paying early (usually within two weeks of receiving the bill), take them up on it.

A 2% discount on a 30-day invoice is equal to a 24% annual return if the money was invested. If your suppliers don't offer this kind of incentive, ask for it as they may be willing to offer the discount in return for speeding up their receivables.

4 - Balance your client base

Many service and professional companies (such as advertising or PR agencies, accountants, attorneys, real estate management firms, etc) that work with certain clients on a project-by-project basis.

Look for ways to convert some of these clients to a retainer relationship, where they pay you a set amount of money per month for a certain number of services. You might want to offer them some kind of incentive value-added services or a discount, to encourage them to shift to a retainer. This might reduce your profit margin, but it will help make your cash flow more predictable.

5 - Check your pricing

Have your prices kept pace with your rising costs? When was the last time you raised your prices? Many small businesses hesitate to increase their rates because they're afraid they'll lose customers. However, customers actually expect their suppliers to institute small, regular price hikes. Also, be sure to check out your competition on a consistent basis. If they're charging higher prices, you should too.

6 - Don't buy all in one place

You can save money by splitting your business between suppliers. Closely examine where you need to pay for added service, and where you can save money by paying commodity prices.

For example, you might want to buy a computer from a value-added reseller who can help you choose the right system to meet your business needs, while you can purchase other items such as printer cartridges, cables, or off-the-shelf software from a mail order catalogue or other price merchant.

7 - Form a buying cooperative

Save money on supplies by rounding up a few colleagues and buying supplies like floppy disks and printer paper in bulk, then dividing them up amongst you.

8 - Renegotiate your insurance and supplier policies

Are you getting the best possible deal on insurance, phone service, and other regular business expenses? Review each of your insurance policies annually and get three quotes for each to ensure you're getting the most for your money.

Keep a close eye on price sensitive services such as your long distance phone service or your Internet access service. Regularly examine these bills and call around to make sure you're getting the lowest available rate.

9 - Tighten your inventory

Overstocking inventory can tie up significant amounts of cash. Regularly gauge your inventory turns to make sure they are within industry norms. You can do this by calculating your inventory turnover ratio (cost of goods sold divided by the average value of your inventory).

Avoid buying more than you know you need when suppliers lure you with big discounts; this can tie up cash. Periodically check your inventory for old or outdated stock and either defer upcoming orders to use that stock or sell it at cost to improve your liquidity.

10 - Consider leasing instead of buying

Leasing generally costs more than buying, but these costs often can be justified by the cash flow benefits. By leasing computer equipment, cars, or other tools you need to expand your business, you will avoid tying up cash or lines of credit that might better be used for running your business day-to-day.

For further information contact your local Business Banking Officer