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the flow
Without cash flow, your business is going nowhere. But exactly how much clear water should there be between your outgoings and your incomings to make for a profitable operation?
Cash is the lifeblood of all transport operations. So in times of recession or rapid growth, the difficulties caused by weak cash flow assume ever greater importance and may quickly undermine the business to the point where it is unable to survive.
The problem
It is necessary to have a thorough understanding of the causes of the problem. If cash is under pressure, the following factors may bc responsible: • poor credit vetting and/or collection procedures, • failure to negotiate appropriate terms with creditors, • excessive operating costs, • insufficient working capital, • inadequate gross profit margins.
All of these failings can damage the liquidity position of a business, although some are more immediately serious than others. Faced with a crisis, the solution chosen must take effect quickly and have a substantial impact. By considering each area in turn, the haulier will be able to determine the most practical course of action in the circumstances.
Credit control and collection
The key measure of your debt collection effectiveness is the Average Collection Period. This indicates the average number of days taken to collect a typical debt. Divide total annual sales by the typical total outstanding sales ledger and multiply by 365;
EXAMPLE:
Next, calculate your Average Credit Period from suppliers. In this case, however, you must work on the due dates rather than the outstanding purchase ledger total. For each category of expenditure or each supplier, list the percentage of your total purchases per annum and the credit period in days: eg fuel, 14% of total purchases; 30 days ca-edit
Finally, multiply these two figures together for each item/supplier and add all these results together. The final figure is your average agreed credit period in days?
Working capital
You can determine an approximate working capital requirement by 2 comparing the average credit period with the average collection period.
w • If, for example, you are due to pay suppliers in an average of 30 days but invoice collections 1are taking 46 days, you will require cash 6 reserves equal to at least 16 days purchases in 2 order to avoid liquidity problems, all other fac14, tom remaining equal.
= If the opposite ratio is true, then the cause of your cash crisis is less obvious and further investigation is required.
One underlying cause of an apparently illogical cash flow squeeze, for example, could be excessive spending on capital equipment such as new trucks. It is possible to drain your business of cash by spending all your trading profits and more on equipment. It is easy to fall into this trap when your business is growing quickly and you are trying to avoid borrowing to make necessary capital purchases.
A shortage of working capital is common in small firms, where growth is often spectacular and the expenditures required to fund expansion are incurred before any increases in cash receipts materialise. A working capital deficit is a serious matter and must be addressed by collecting debts more quickly, injecting new capital into the business and/or reducing / costs.
Cost reduction
A cash crisis may demand crisis measures to alleviate the situation in the short term and make a breathing space to allow the root causes of the problem to be addressed over several months, Cost cutting is the most obvious action as it is immediate. But the only effective way to achieve significant cost reductions is to adopt the principle of zerobased budgeting.
Assume that your business will spend no money on anything. Then consider each area of expenditure item by item asking two questions;
• Is this item necessary for the survival of my business?
• How can the level of expendimre on this item be reduced?
Concentrate first on fixed, or overhead, costs such as rent, salaries, and leasing which represent a high proportion of total costs.
A small haulier will often find that he is able to draw only a modest salary but may have fixed costs running to thousands of pounds each month. This is not acceptable.
Remember that we all have 'sacred cows' where cost cutting is concerned. You will tend to overlook the possibility of cost reductions in some areas unless you force yourself to do the job thoroughly. Pay close attention to significant cost items which have been purchased from the same supplier over a long period. Are you paying too much for fuel or tyres?
Gross profit margin /1/ 0 try. Check out your competitors to establish The profit OD materials is the percentage of your selling price which remains after deducting the cost of raw materials and direct labour. Generally if this margin is less than 40-50%, it will be difficult to achieve adequate returns from the business, as gross profits must be deducted from fixed operating costs before a pre-tax profit is achieved.
Clearly this is a generalisation and gross margins vary widely from industry to indus the gross margin norm for your industry and airn to exceed it by 5%.
It has been correctly observed on many occasions that under-pricing has been the ruin of many a good business. Your gross profit margin is the single most significant measure of your performance. Remember that increases in gross margin will be reflected fully in your net profit Earning 10% net profits on sales would increase those profits by 50% if there was a 5% improvement in gross margin. More businesses fail as a result of cash flow pressures than for any other reason. Many thousands of good, profitable firms have fallen. The management of cash is a fundamental discipline. Business owners must have an accurate perception of their cash position at all times if prompt action is to be taken when things threaten to go wrong El by Alan Bowes