Why cash is king – Sarah O’Toole, partner Grant Thornton

Sarah O'Toole

By Sarah O’Toole, partner Grant Thornton

It’s commonly said in business that “profit is sanity, turnover is vanity”.

For me, there is a third guiding principle for business owners, particularly those in growth mode, and it’s that ‘cash is king’.

In my experience, managing cash is an over-arching and critical discipline, applicable to companies across every sector.

Essentially cash is the lifeblood of a business and not managing it can lead to serious consequences.

Often businesses on a growth trajectory have a tendency to focus on sales, sales and sales, and can become unstuck when they start to over-trade.

Over-trading is essentially where a company is focused so much on driving the top line that it isn’t looking after the working capital and cash and becomes illiquid.

It is something that we see a lot of in periods of economic growth and this can happen not just in start-ups but also in long established businesses.

The key message is to make sure that businesses are not just focused on the top line and they have an eye on their cash position by having the right tools, early warning systems and KPIs in place.

Sometimes we take for granted that management teams are doing this. I am often surprised by the lack of robust cash controls in the businesses I encounter, particularly those businesses with a history of strong trading.

Management may look at the P&L account and say: ‘We’re doing great, we’re profitable, turnover’s growing and we’re on an upwards trajectory’, and then they suddenly find they are unable to pay the company’s suppliers and meet other obligations, because there is insufficient cash to do so.

How to tighten up your cash controls

As I’ve said, a business can have fantastic revenue, be profitable and trading in a growth sector, but if its finances are not structured and managed, it could still have cash flow issues.

A first step in establishing a tight rein on cash is to look at working capital optimisation – which covers credit control, supply chain management and inventory management.

In other words, ensuring cash is not tied up in debtors or stock and that you are getting the best terms possible from your supplier base. Ensuring you have robust cash flow management and cost controls in place, and that you are running as tight a ship as you can is essential.

On the debtors’ side, sensible strategies include making sure that you’re invoicing as promptly as possible, and you have systems in place to chase those invoices down – perhaps offering discounts for early payment.

Your business may not be of a size where you can have a full credit control function in place, but you should certainly have a system in place where if someone doesn’t pay within your credit terms, steps are taken to recover that debt.

You should, of course, be credit referencing your customers, so if their credit rating deteriorates you are aware of it. You can then take steps to avoid bad debts by changing payment terms. Making sure you have not got cash tied up in debtors is key.

Similarly, on the creditors’ side, you have to make sure you’ve got the most beneficial trading terms as you possibly can from your suppliers, and that you are shopping around for the best deals.

The worst case scenario for a business with cash difficulties is being placed on pro forma invoicing by their suppliers.

This can lead to daily cash management and a “hand to mouth” existence with management being unable to strategically manage the business. It is not uncommon for a downward spiral to ensue in such circumstances.

If a business has a cash flow forecast on a short term basis that looks, for example 13 weeks ahead, and then another looking at an annual basis, it will have visibility on when it’s likely to have cash surpluses.

Management can then plan what to do with these reserves. On the flip side, forecasts will give visibility on when there is going to be pinch points in the cash flow.

Some businesses that we see will have pinch points in the payment cycle, particularly around VAT and rent quarter days, or monthly wages runs.

If all three are due on the same date and there is not enough cash in the business, then there can be serious consequences. It’s essential therefore to manage cash through these working capital cycles. Careful planning is therefore required from directors around the timing of their drawings for example.

If there is a cash hole in the business the most appropriate solution is often an equity injection; business owners should consider this as an option before ploughing more debt into their business.

When management teams face a cash critical periods in their trading cycle, they should be addressing issues through making changes to the business, such as cutting costs or making the operations as lean as possible.

Management teams who focus on a turnaround, address the issues head on and seek advice from trusted advisers will be best placed to survive a cash crisis.

It’s easy sometimes to not to fix the problem and to kick the issue it further down the road in the hope that everything will come good at some point.

While there’s nothing wrong with optimism in business – we still need executives to be realistic and ready to act in the long term interests of the company if it is to thrive into the future.

If you’d like to discuss cash management, working capital optimsation or funding for your business with a member of my team please get in touch.
For more expert business insights from the Grant Thornton North West team, please click here.

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