Cash Flow - Pinpointing the Issues and Fixing Working Capital Deficiencies

We continually read that ' cash flow ' is the ' life blood ' of any business. If that's the case, and we believe it is!, then how do business owners look for cash flow gaps in their business and fix them.

Lets look at what we will call ' red flags ' in various parts of our business. What are the warning signs related to those red flags, more importantly, how can we fix them.

Most business owners are familiar with the working capital ratio - that is current assets / current liabilities. We are told that a healthy ratio is often 2:1. That means of course that we should have two dollars of cash, inventory and receivables for every dollar of accounts payable and short term debt. A more important red flag is for business owners to focus on another version of the above ratio, often called the ' acid test ratio. That ratio has the business owner taking just cash and receivables and dividing that by the current liabilities number. If the acid test ratio is significantly deteriorating then the business owner should of course recognize a warning flag.

Clearly whenever a business has their bank returning cheques to suppliers etc that is a major warning sign that over all cash flow in the business is not sufficient. Business owners may also check one other vital sign, and that is their payables balance. If payables are increasing and the firm is no long able to take advantage of prompt pay discounts from suppliers that also forewarns cash flow problems and challenges.

Businesses also have term loans outstanding, and naturally any inability to make a pre - agreed upon loan or lease payment is a critical warning sign of cash challenges.

I meet with many owners who continually tell myself they are always ' chasing money '. That is to say they are focused often times more on trying to collect receivables as opposed to growing their business.

Another ratio, ( we like to call them a ' numbers relationship ' ) is the relationshiip of current liabilities to inventory. If this number is higher than historical norms or the industry average then clearly the owner has a sense of a clear warning sign. If, of course, any secured lender or supplier has filed a legal action for non - payment, well, suffice to say, that's a warning sign!

So, we have addressed two key issues in the business owners cash flow dilemma - the deterioration of working capital and the increase of debt in the business.

How can these issues be fixed.? Can they be fixed? Business owners need to focus on restoring the company to historical profitability. They also need to take a strong look at items such as salaries, bonuses, and the bonusing of dividends - these have clearly drained much needed cash from the business. The business may also be more wary of assuming large contracts which tie up inventory and receivables at a time when liquidity is weak. Customers owe the business money. Focus should be on prompt collection according to agreed upon terms of payment.

Business owners can also take a look a slow moving inventory and any assets that are not being used in the business. By addressing these two issues additional liquidity can be brought into the business.

In summary, we have discussed how business owners can see, and spot, and plan for issues relating to the deterioration of working capital and debt load. Prompt and ongoing work in these areas can ' unlock ' that valuable life blood in the business!


Stan Prokop is the founder of 7 Park Avenue Financial . The firm specializes in business financing for Canadian companies     in the areas of working capital , asset based lending, SR & ED tax credit financing, equipment financing,  franchise financing and banking .


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