Muhammad Asif is an entrepreneur, investor, and CEO of MCA International, a firm providing growth-focused solutions to hospitality industry.
One of the biggest issues businesses tackled during the Covid-19 pandemic was cash flow and cash flow management. Some businesses folded early in the pandemic due to not having sufficient cash reserves on hand. Others managed to stay afloat for a while, but eventually their cash flow ran out too. The organizations that survived the lockdown are the ones who were prepared for a catastrophe and were cash-flow rich.
As a CFO, I understand the ebbs and flows of business. Pandemic aside, it is simply unrealistic for a company to expect to survive long term without robust cash reserves. Maintaining finances month to month while leaning on the occasional bridge loan is not a healthy way to run a business. It’s understood in the business world that companies have bad years. In fact, one can almost bet on a downturn, even if it’s a small one happening every five to ten years or so. It is the lifestyle of business! But if cash flow is planned properly, the effects will not be as dramatic as it would otherwise.
The truth is, we do not know if or when we may end up going back in lockdown. We hope that we are on the right path to herd immunity and getting back to “normal” with global vaccinations but we can not tell the future. Remember last March when we thought we would only be in lockdown for a couple weeks? It is, therefore, crucial that your company be prepared for anything to pop up.
Before I share ways to make sure your company is ready for another lockdown or downturn, I want to make sure the difference between cash flow and marginal cash flow is understood. It is imperative CFOs and finance directors understand the distinction as they plan and strategize in the short-term and long-term. A cash flow is a measure of a business’ cash ins and outs over a period of time. A marginal cash flow is the cash left over once the cost of goods sold and working capital requirements have been satisfied. The formula for determining marginal cash flow is Gross Margin % Less Working Capital %; it is hence the difference between your gross profit and working capital requirement.
This is important to know as it shows the amount of cash available for a business to cover its overheads and ultimately profit. It will also answer a key question whether more revenue will lead to more profit. Therefore it is important to work on this and get right before pushing ahead with more sales. The marginal cash flow can be shown as a percentage or an absolute number. There is no right or wrong answer or benchmark as all companies are different but a year on year increase is a good indicator of a company’s cash strength.
A robust cash flow is important but will not happen overnight. Here are four ways companies can start to better manage their cash flow.
1. If your company does not have a CFO or a financial director, get one ASAP. In my view it is not an expense but a key investment. If you can not afford a full-time CFO, use a freelance or contract CFO. It is critical to have someone focused entirely on your business’ financials and the overall financial health of your company. Particularly someone that understands the ins and outs of business and finance strategy and will be able to manage the cash flow.
2. Once you have a CFO in place, it’s essential the entire C-suite is on the same page. It is not uncommon for the CEO and COO of an organization to work with the product or engineering team on a project without informing the CFO. And when additional funds or headcount is needed, the CFO is blindsided and unprepared for the new expense. The CEO, COO, and CFO need to work in tandem－there should be no surprises. The best teams will always have the C-Suite working together, they will all compliment each other and be able to have intervention strategies as and when they are required – this will also allow for bold decision making.
3. If your cash flow is struggling, look into renegotiating or extending terms with your vendors. Given the current circumstances, many landlords are giving temporary relief on leases and adding additional time to the end of terms. Also, vendors are usually willing to extend payment terms from net30 to net60/90 to loyal customers. If they aren’t, ask if they have an early payment discount. You’ll have to pay sooner, but it may lead to a smaller payment. Also remember to ask for payment holidays if required from your lenders.
4. Take the time to evaluate your expenses on a quarterly basis. This is an important exercise to do, especially if you start to look at your overall cash flow and marginal cash flow as I described above. It is less about cutting corners and more about making sure your business is spending intelligently. When positioned against the ultimate goal of staying in business (and indeed thriving!), you’ll see which expenses are a “must” and which are a “nice to have”.
The most important way to be prepared for an unexpected event is simply the awareness that it could happen. Many businesses were taken completely off guard by the pandemic and never fully recovered. Taking the time to assess your financials and putting together a plan is half the battle. The C-Suite should always be thinking about ensuring there’s a sufficient cash cushion so the company can tackle a bad year head on and increase its probability of long term success.