If you, like me, drive around town regularly, you will be familiar with the occasional car – usually a taxi – that has come to a stand still because the fuel tank has run dry. Next you will see the driver pick a bottle or small jerry can from the trunk and empty its contents into the filler gap. The one or two litres of fuel thus added will allow the driver to reach the next fuel station or run dry again. In the last case he will now make it to the nearest fuel station on foot to fill up the container and go back to the car, which has most likely been left on the road just where it coughed itself to a final stop. Running out of fuel doesn’t seem to be a reason to panic for the driver as it happens frequently and he is used to running on empty. He makes ends meet with the little money he scratches together day by day; a hand to mouth way of making a living.
It is like running a business on credit although the consequences seem more drastic as the car abruptly comes to a stand still once the engine runs dry. Normally there are warning signs as the fuel meter reaches the red area, unless of course it doesn’t work anymore, which is not unlikely. In that case the driver estimates how far the little fuel left will still take him but often misjudges the distance he can still go.
Similar practice can be observed in running a more formal business as the cash at hand falls short of the required running costs. There may be warning signs but just as in our example above, they may be misinterpreted or ignored. In the worst case there are no warning signs – like in the case of the dysfunctional fuel gauge – as there may be no system in place providing essential management information, based on which appropriate and timely measures can be taken. Anyhow, the business owner will now turn to the crisis management mode, a strategy we are good at in Ethiopia but which rarely provides for lasting solutions to a recurrent problem: stagnant cash flow.
The crisis management strategies thus applied will include using money which was reserved for other important purposes (savings for example or maintenance), borrowing money or taking a bank loan. Where the business owner has a good relationship with the bank and the bank considers the business creditworthy, they may agree on a credit facility. Formal credits and loans cost money though in the form of interest and should therefore be kept to a minimum.
It is surprising though that many businesses are run without basic systems in place to manage the finances of the company. Like in the example of the taxi, it is hand to mouth. In addition the finances are usually supervised by the bookkeeper or the accountant, while the secretary handles the petty cash. Rarely are the data provided by the accountant analysed to provide strategic management information. Another issue is that the business owner may decide to provide services to frequent clients on credit. While this seems a good strategy to attract and keep clients this is not without risk either as it is sometimes difficult to recover credits in time. This only leads to more crisis management and meanwhile the company is running on empty. This is not a good situation to be in as the running costs need to be paid, like rent, utility bills, production costs and not to forget the salaries of the workers.
So what can be done to avoid the dreaded recurrent stagnation of cash flow and to prevent having to resort to crisis management all the time? Without pretending to be exhaustive, here follow a few simple suggestions that may help, as I observe that many small businesses don’t have such rather basic measures in place.
Have a financial management policy, which describes the monetary dos and don’ts in your company. Here you describe all financial management procedures you want to follow, set the limits of outstanding credits, stock value, reservations, etc. Make sure you adhere to it and your managers know the policy.
Make a budget and make sure to include all production costs and overhead in your pricing.
Have a contingency plan and replenish your contingency fund monthly.
Appoint a finance manager who is capable of analysing the financial situation of the business, points out risks in time and suggests corrective measures to management.
Review your financial situation frequently and adjust your plans accordingly.
Negotiate a credit facility with your bank and include payable interest in your pricing.
Be service minded, build good relationships with your clients and provide incentives to encourage timely payment.
Deliver high quality services and keep your promises to enhance your own trustworthiness.
Get rid of defaulters.
Manage your finances in a disciplined manner, make savings, reinvest and avoid unnecessary consumption of hard-earned profits.
Be proactive and don’t wait until it is too late.
In conclusion: Keep your business financially healthy; don’t run it on empty. Once it stalls it is not easy to kick start it again.