Cash maketh the SMB: How to ensure your small business always has cash in the bank

In the words of a successful entrepreneur, profit may be optional, but cash is mandatory.

All decisions regarding customers and contracts impact the amount of cash the business generates. SME owners dislike losing orders. The fear of losing the order occasionally clouds decisions about the order profitability or its capability to generate more business. Being the final decision maker, it’s hard to negotiate with procurement organisations of larger firms. 

The choice of customers is crucial, and it’s important to say ‘no’ to bad customers, i.e, those who don’t pay enough, delay payments, and reject your product or service for no credible reason. It’s important to review contracts with sub-optimal profitability, especially those with old ‘loyal’ clients at generous contract terms, for example, 90-day credit periods, which come at a cost, both in terms of interest payments, and loss of more profitable ventures.

The importance of a solid contract

Exports contribute a significant percentage to several SME businesses. While entrepreneurs typically control new operating costs (in terms of logistics) and timelines (when customs is concerned), they may experience cashflow problems from fluctuating exchange rates.

The prevalent contractual construct in the manufacturing industry, where rates reduced every year on the expectation of higher productivity, was famously pioneered by Maruti. A few progressive manufacturers used this externality to initiate global joint ventures and develop world-class frugal manufacturing processes. They continue to closely manage productivity, inventory, and receivables, and invite worker participation to reduce costs and optimise inputs.

Investing in assets: dos and don’ts

The SME entrepreneurs often stretch limited cash reserves to invest in ‘world-class’ facilities. In several instances, investments made in facilities to meet the buyers’ specifications ignore the capability and capacity utilisation. SME owners take such decisions on gut feel vs a well-informed financial case justifying returns on investment.

In the early survival years, necessity should drive investment. Customers pay for deliverables at contracted cost, quality and time - not on whether you used expensive machines to meet requirements.

That said, do invest in the best machines, when possible. Longer work-life, higher quality, lower maintenance costs more than pay for the higher initial outlay. Industry veterans share several anecdotes: for example, Chinese machines at 10 percent of the cost of German or Japanese machines are just not that precise.

Credit raised on short term rates is often diverted to long-term asset creation. While sometimes necessary, such repeated behaviour places an inordinately high interest load on the cash flows from your existing business.

How SMEs should raise debt

Access to capital is a challenge. Most often, the issues entrepreneurs think they face is how they should raise funds. But the problem lies in the fact that more crucially, they have no clear vision as to why they are raising funds. Raising any kind of capital comes at a cost, and business plans justifying returns should be a precursor to capital raise.

Most SMEs do not have the ‘luxury’ of tapping into venture capital. This is still the mainstay of sexy, fast growing and seven-year exit sectors, usually technology driven. Equity investment is available via strategic partners or PE firms, especially if you run a business with a good track record in a high-growth sector.

Equity is expensive, involves shared ownership, a not-easily-dissolved ‘marriage', and comes with longer-term implications. SME owners don’t realise later that such investors are interested solely in financial gains.

Secured and unsecured debt is the staple for SMEs. Banks are awash with capital, and a vibrant banking sector provides considerable options to SMEs. Lately, debt is not in fashion as it has a procedural and compliance issue, while the glamour and perceived ease of raising of ‘investor’ capital is more attractive.

Making a case for KPIs

Comprehensive key performance indicators (KPIs) need to be promoted at all levels. Consistent and continuous investment in training people, with a focus on systems, processes, and quality ensures KPI achievement and top-line returns.

Several software tools allow you to track activity and generate reports on a daily, or even hourly, basis. Tools that track machine uptime and round-the-clock utilisation impact productivity. In one instance, the night shift doubled productivity from earlier levels. Accounting systems track financials and provide the ability to do multi-year analysis, identify corrective action to take, and model business plans and projections for the future.

Startups are coming up with innovative tools across all functions: aggregating online procurement to drive better and timely bargains, deploying IoT based solutions to monitor timeliness and energy efficiency, and several others.

A lot of these are still not used effectively. The data of every single business decision is available, but the entrepreneur seems lost in the maze of data, and tends to ignore the same. Many SMEs do implement popular software and process tools like ERP for collating various data in business. However, very little of this software is actually used and too little time is invested in reviewing them regularly to take corrective decisions that maximise benefits and/or minimise costs.

According to a senior entrepreneur running a large manufacturing enterprise, less than five percent of the functionality of purchased software is used. His effort was to use around 20 percent of functionality – a best in industry class – resulting in higher quality, lower rejects, higher reuse and automation, and higher profits.

The focus

Entrepreneurs, primarily technocrats, invest time in core domain areas and operations, even after 20 years of running their business. This has two serious implications:

First, the entrepreneurs operate like 'owner-managers', i.e, they invest time and energy in managing the business than owning it. More time is spent on doing versus reviewing, on internal cost optimising versus external revenue/profit-generating activities.

Second, with no formal education in cash flow management, it’s an area delegated to an external auditor or a junior chartered accountant, who meet the entrepreneur infrequently and limit advice to either meeting government regulations and/or minimising tax payments. The entrepreneur often doesn’t appreciate the power of the data and insights derived from their businesses’ own financial statements, or the necessity of obtaining strategic advice to position the business for future growth vs. optimizing to save tax.

For growth, the focus should be on increasing topline complemented by proper cashflow management systems, and an appreciation of the accounting heads that translate topline to healthy bottomline. Cash-in-the-bank allows you to invest in machinery, hire and develop people, expand facilities, experiment with different customers and contract terms, enter new geographies - everything that will help you grow your business.

(Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of YourStory.)

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