Business beaver (From Wiltshire Business Online)

Business beaver

11:00am Monday 11th May 2009

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It’s unclear who first coined the well known phrase “Cash is King.” But what is certain in the current economic conditions is that the ethos it encompasses has never been more important.

I was recently asked to prepare a small presentation on the topic for a seminar to SME business owners and the message from that presentation bears repeating in this month’s column.

I took an example of a small start up business selling a product at a healthy 60 per cent gross profit margin with the usual array of other costs, wages, delivery overheads etc.

At the end of the first year my example company showed corporation tax due the taxman of £6.9k, profits retained by the owners of £27.6k and cash in the bank of £77.6k. A unique trilogy of the business owner, taxman and bank manager all being satisfied by the same business at the same time!

Unique indeed and in fact totally unrealistic because I’d assumed that all my customers paid on delivery, I paid all our suppliers on delivery and I didn’t need to hold any stock. Once you start bringing some realism into those assumptions of customers paying in 60 days, suppliers demanding payment in 30 days and having to hold two months stock on hand a different picture emerges.

The business owner and taxman are still relatively happy with their “takes” from the business holding up at £25.8k and £6.5k respectively but the bank manager is deeply unhappy because the bank account has plunged by £143.9k to an overdrawn position of £66.3k.

The example went on to demonstrate how sensitive the cash flow was to the fine tuning of those “terms of trade”. By reducing customer payment terms to 45 days, extending supplier terms to 45 days and reducing the stock holding requirement to one month instead of two the bank balance at the end of year one returns to a small positive balance of £3.7k.

The conclusion to make is that while every business is unique in its cash flow and funding requirements effective working capital management is generally not sufficiently prioritised by the business owner and this is often due to a lack of understanding of how cash moves through the business.

In the current climate understanding this factor can make the difference between survival and failure so if you don’t understand this for your business; ask your accountant to explain it to you.

If you’d like to look at the example referred to above in more detail please drop me an email at rob.harman@morrisowen.com and I’ll happily send you a copy.

• Contact Rob Harman at Morris Owen on 01793 603900

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