Cash is vital to any organisation, large or small.  But quite often smaller businesses feel the cash flow squeeze when doing work for larger customers because they lack the commercial leverage or scale to negotiate shorter payment terms.  In some cases (particularly in the construction, food and beverage and transport sectors), critical suppliers can also be inflexible when it comes to terms.  This can put extra pressure on cash flow, particularly when suppliers are being paid faster than customer sales are being collected.

What do SME’s need to alleviate some of the strain?

The answer is discipline.  A disciplined approach to working capital management.  It starts with the simple exercise of mapping the working capital cycle to show management what is and is not in management’s control, and what processes and procedures are key to ensuring the working capital cycle is as short as it can be and the fewest possible steps are “left to chance”.

Recently the McGrathNicol Cash & Working Capital Centre of Excellence assisted the management of a SME-sized transport business with a review of its working capital cycle and cash flow.  It was found that (on average) the business was paying 14 of its top 20 suppliers earlier than agreed terms, but collecting from 14 of its top 20 customers later than agreed terms.  The business had procedures for debtor management, but those procedures didn’t kick in until the debtor had fallen overdue.  This was putting the business’ cash flow under enormous strain.

What needed to change, and how can this be applied to all SMEs?

Firstly, debtor management needed to start from the moment work began on an order and ramp up once a sale was made.  Clear procedural steps were required to ensure that all staff across the sales, operations, finance and admin teams were on the same page, and that an accurate invoice could be raised as quickly as possible.  This was key, since a customer will usually only pay if it has received an invoice.  Ensuring customers paid on time was the next challenge.  This required clarity around responsibility and increased contact with the customer before the invoice due date.

Similarly, on the supplier side, paying late or stretching creditors is not sustainable but there is generally no good reason to pay early, unless there is a discount on offer and even then, that discount must be better than the financing rate and be better value than having the cash in your own hands.  Clearly setting out the steps in the procurement-to-pay cycle and assigning responsibilities helps ensure suppliers are paid on time (and no earlier).

For our transport business client, bringing the top 20 customers and suppliers back to within terms improved cash flow by over $2 million.  This made a significant difference, and took the pressure off funding lines and ultimately gave management the flexibility to look at capex and other strategic programs.

So whilst negotiating more favourable terms should always be an objective of management, immediate cash flow improvements can be made by looking in-house, ensuring clarity around processes and responsibilities, and taking a disciplined approach to working capital management.