A Complete Guide to Managing Small Business Finances

A Complete Guide to Managing Small Business Finances
15 min read
03 January 2023

Managing the finances of an SME : the importance of cash

Cash is essential to deal with growth in activity or during phases of conquest. Working capital needs, cash flow forecasts... Here's how to better manage your incoming and outgoing flows.

Cash is the sinews of war for an SME . During the operating cycle, you buy materials or goods, conduct marketing or operations, and then deliver and invoice your products or services. Unfortunately, you usually have to wait to collect receivables. Time during which money is not available for a new cycle. This period of inertia requires a permanent cushion of liquidity . Cash flow is therefore a very sensitive area, which must be monitored on a daily basis. Especially since the combination of constraints makes things very complex.

In addition to controlling social security and tax deadlines, there is, among other things, the planning of supplier payments (the deadlines for which must be compatible with the ability to collect customer receivables), the climate of trust to be established with bankers, forecasts of business activity and the availability of sufficient capital. A balancing act that involves knowing how to juggle actual and forecast, incoming and outgoing flows .

Calculate your working capital requirement (WCR)

The cash (T) results from the difference between the working capital (FR) and the working capital requirement (BFR) according to the equation: T = FR - BFR. Working capital corresponds to the excess of permanent capital (equity capital and long and medium term loans) over fixed assets. The working capital requirement represents the amount of capital needed to finance the operating cycle. It is calculated in parallel with the preparation of the annual business plan. This document describes the growth ambitions of the company and, from there, its need for working capital. Will the company's growth be the same? Are you considering the launch of a new product involving an increase in your purchases of raw materials? Do you plan to prospect new customer segments with later payment terms? So many questions whose answers will influence your need for working capital.

Then, you can quantify the stocks of raw materials and finished products , which the company must have at all times, taking into account the supply rates, manufacturing constraints and the level of activity of your company. You will also need to assess your outstanding customers (the amount of your receivables awaiting settlement) and your supplier credit (the total of your supplier debts).

Once this costing has been carried out, you can calculate your working capital requirement according to the following operation: average stocks excluding tax + average outstanding amount of customer receivables including tax - average outstanding amount of supplier credits including tax. Calculated on the closing date of the accounts, the working capital requirement is not necessarily representative of the company's permanent needs , and must also be analyzed from a development perspective.

You may also read: How to Improve Your Company’s Customer Lifetime Value

Fluctuations in working capital requirement

Careful monitoring of your main indicators will allow you to quickly notice an unexpected increase in your need for working capital . But even without that, there are some risky times that need to get your attention. BFR increases with growth. The mechanics are as follows: seeing an increase in its order book, the company is led to make significant investments (in raw materials, machinery, personnel, etc.) Its need for cash, not yet covered by its receipts, increases therefore at a rapid pace, like the fuel consumption of a car traveling at high speed. This is a critical phase that requires the greatest vigilance. But it is not only the periods of strong increase in activity for which the problem of the need for working capital arises: the phases of conquest- for example of a new international market - are also risky periods for WCR and cash management. Cycles are then disrupted and development is cash-intensive. Any change in the FR or the BFR will therefore have immediate repercussions on the cash flow . This is what the flow table allows you to analyze (see model below).

 
Sales/production
- Intermediate consumption
= Added value
- Payroll costs
- Taxes and duties
= Gross operating surplus
+ or - Change in working capital requirement
= Operating cash surplus
- Investments
= Operating balance
+ Contributions or capital increase in cash
+ or - Financial result
+ New borrowings
- Borrowings repaid
- Financial investments
+ or - Exceptional result
= Overall cash flow before distribution
- Corporate tax
- Employee
profit-sharing - Dividends paid
= Changes in cash

How to build a cash flow forecast?

Two types of tables allow you to model your cash flow needs :

  • The cash budget : It forecasts the evolution of the cash flow for the following year, month by month . It is compiled at the end of the accounting year from other budgets already drawn up. You must first validate the upstream budgets (purchases, sales, human resources, etc.) and weight them if they are too ambitious. Then, carry out two restatements: change the accounting date flows to flow dates and calculate the monthly VAT disbursement. To do this, apply to sales the average payment terms observed in the past and define rules for the different charges.

  • The rolling cash plan: Unlike the budget, which is a fixed forecast at a given time, the rolling plan, derived from the budget, is constantly updated. You advance the horizon as the year unfolds. This plan can be monthly or weekly, and the forecasts for the next twelve weeks are alongside the actual results for the past nine months. It makes it possible to compare disbursements with receipts and to justify short-term credit requests (discounts, Dailly, overdrafts, etc.). At each time interval, compare the flows made with the forecasts, calculate the differences and update your forecasts
Expert
opinion Pierre Grafmeyer, chartered accountant, statutory auditor, partner at Odicéo (Villeurbanne)

"Cash is the supreme judge"

Wishing to remind SME managers that "the result is different from the cash", Pierre Grafmeyer , chartered accountant partner of the firm Odicéo , returns to the fundamentals. "SME managers often have their eyes fixed on the development of their business and its profitability, but even with good results, without cash, a business can be put at risk ." The working capital requirement (WCR) must be balanced. To finance it, the manager must both limit his customer credit and optimize the management of his stock. The expert recommends "the establishment of a procedure for controlling receipts from the customer account , subject to daily monitoring". "Because, he insists, selling is good, collecting is better !" He also advises business leaders "to anticipate their BFB by using Oséo financing " to support their development and have the cash flow adapted to their growth.

Action levers to improve your working capital requirement

In order not to curb your growth by running out of fuel, you have several levers, to be operated together or separately, depending on your needs and your sector of activity:

  • Action on the trade receivables item : The rapid improvement of working capital requires the reduction of the duration of the credit granted to customers . However, it is not easy, for obvious commercial reasons, to demand immediate payment, unless you offer a discount rate (a discount for cash payment) that is particularly attractive, but potentially costly for the company. Because in times of low rates, paying agios on overdraft often costs less than offering a financial discount. Depending on the bargaining power you have with your customers and the rules in use in your sector, you can try to reduce the payment period below the 60 days (or at the end of the month after 45 days) fixed by law. of modernization of the economy of August 4, 2008, in force since January 2009. Failing this, at least make sure that customers actually pay you on the due date. Because the older a debt is, the more difficult it will be for you to recover it. Some customers need systematic follow-up and prioritize their payments based on the intensity of the "harassment". Hence the importance of entrusting customer follow-up to employees who combine firmness and diplomacy. The sales variable can thus be indexed to the turnover collected and not realized, which encourages them to be more attentive to the solvency of customers and the collection of receivables.

  • Action on the supplier position : This action simply depends on the weight of the company vis-à-vis its supplier to obtain longer payment terms. For this, only competition between suppliers is effective , provided that the company has sufficient critical size. It is also wise, for strategic reasons, to multiply its sources of supply.
  • The bank overdraft : Line of credit granted by the banker, the overdraft is the only financing solution in which no debt is required in return . Like other short-term loans, it is indexed to the base bank rate (6.60%, plus the bank's margin), which is itself set according to the money market rate. An amount that deserves that you take the trouble, before resorting to the overdraft, to check the financial conditions attached to it. In addition to the amount of the agios, compare the commissions, and in particular the "commission on the strongest overdraft" , that is to say the rate applied, each month, to your largest debit balance.

  • Factoring : This technique consists of handing over all or part of the trade receivables to a third party (referred to as the "factor"), which ensures the immediate payment of these in return for the payment of a commission, which can amount to 1. 5% to 3.5% of receivables entrusted. There are two categories of factoring contracts: the factoring contract without customer risk management , where the "factor" only advances the amount of the debt and requests reimbursement if it turns out that the debt unpaid, and the factoring contract with customer risk management , which makes the factor assume the risk of unpaid. In this case,Factoring is a valuable source of short-term financing . However, the duration of the credit that the factor provides is limited in time and does not exceed three months of turnover. The cost of the factor, for a commission of 3%, then represents an overall annual interest rate of 12%. Contrary to popular belief, factoring is not intended for companies with structural cash flow difficulties, but for successful SMEs experiencing difficulty in managing their growth or outsourcing the management of trade receivables.

  • Discounting : It is always possible to discount bills received from customers at banks , sometimes at a high interest rate. Discounting, a technique for mobilizing the company's trade receivables, is the credit operation by which the discount banker makes available to his client (the supplier company) holder of a trade receivable materialized by a trade bill. (most often a bill of exchange, more commonly called a "treaty") the amount of this claim less its remuneration, subject to transfer of ownership of the commercial paper.
  • The credit line granted, limited, is nevertheless superior to that of an overdraft, since it is based on a debt. Another advantage: when your customer agrees to sign the draft, he undertakes to recognize the veracity of the invoice and can therefore no longer contest it, unlike a simple invoice. But the discount also has disadvantages. Delays are long in the case of paper drafts, which are gradually being replaced by electronic drafts. In addition, some customers are reluctant to sign this document because they then give up questioning your service. In addition, the banker can refuse it if he considers the risk too high.
  • The Dailly Law : It is also possible to assign or pledge certain receivables to banks according to a debt mobilization procedure provided for by the Dailly law of January 2, 1981 . This device allows you to assign your receivables to your bank in exchange for a line of credit . Less expensive than overdraft, but more than discount, it is anticipatory financingthe cost of which is indexed to the basic bank rate, to which is added a margin set by the bank (between 1.10% and 5%). Cash is available within 48 hours, especially since some banks have implemented computer tools allowing you to send "Dailly" slips via the Internet. But this technique has a drawback: if your customers do not pay on the due date, unless they have subscribed to credit insurance, your banker will debit the amount from your account. It is, in fact, a simple pre-financing, where factoring companies, or factors, offer more generally to manage customer accounts and cover the risk.

  • Action on stocks : Stocks are analyzed as dormant cash , and tight flow management is in tune with the times. Optimization consists of maintaining a stock level of raw materials that is as low as possible, or even zero . This result depends on the length of delivery times and the security of supply routes, because maintaining a low level of stock should not be done at the risk of a supply disruption, which often costs more expensive than running a small safety stock. The work in process stock depends on the speed of the production process, which determines the number and duration of operations required to manufacture the products sold. Outstandings may decrease thanks to production reorganizations. A quick analysis makes it possible to verify that it is often easy to reduce stocks through improved computerization.

Article By : Amit Chauhan

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Amit Chauhan 2
An optimistic believer in digital’s transformative power on the landscape of B2B2C marketing. Amit brings over a decade of experience to his role as CEO. He is...
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