It’s not Rocket Science

Posted by on Nov 19, 2013 in Academic Research, Balance Sheet, Drivers of Cash Flow, Working Capital

The truth is in the cash flow

It’s not Rocket Science

I was recently at a function put on by Enterprise Connect, a Federal Government body, established to help small and medium size business grow and prosper.  It included a short presentation about their Business Review programme, from which a number of facts stood out.  The first was that Enterprise Connect had completed 6,200 business reviews since inception.  The second was the characteristics of the businesses reviewed: 63% were manufacturing businesses, 79% had sales between $1m and $10m, and 69% employed less than 30 staff.  Thirdly, the critical issues identified by most business owners where they needed help were Cash flow management; Profitability; Succession; and Business Ecology.

This presentation reinforced my belief that The Truth is in the Cash Flow, and that small and medium size business recognise this, but are not equipped, or do not feel equipped, to find their truth.  So, with this in mind, I am going to embark on a series of blogs to help inform owners of small and medium-sized business (and their advisers) about how to use their existing financial information to effectively manage their cash flow.

I thought I would begin by looking at the academic research on the importance of cash flow management to small and medium business.  I have drawn my inspiration for this blog from an excellent website, The Conversation.

You will find on that site four articles summarising various aspects of 5 research projects into small business cash flow management.  These articles were all published by Tim Mazzarol, Winthrop Professor, Entrepreneurship, Innovation, Marketing and Strategy at the University of Western Australia on The Conversation website between 1 January 2013 and 3 February 2013.  The research projects were undertaken in Australia, New Zealand, Europe, The United Kingdom and the United States of America.   In total these projects drew on information from more than 17,000 small and medium-sized business.

Whilst you can read the articles in full (and I encourage you to do so) I have summarised what I think are the relevant and practical findings for the time poor:

Although the research reviewed deals with different aspects of cash flow management, each paper shares a common focus on the benefits of working capital management (ie: the management of debtors, stock and creditors).

Businesses that have a shorter cash conversion cycle (ie: those that manage their working capital) have better liquidity, require lower levels of capital to support business activity and enjoy better Returns on Investment than firms that do not manage their working capital.

There is a significant and positive correlation between the level of involvement of the business owner in the financial management of the business and its financial performance.

Most business owners believed their bank statement and annual accounts to be the most useful sources of financial information.  Few business owners receive a cash flow statement on a regular basis.  A high proportion of business owners do not produce a budget profit and loss, or attempt to forecast their cash flow.

So, the Enterprise Connect presentation identifies that many owners of small and medium-sized business are concerned about cash flow management.  The research indicates that there are significant benefits to business from actively managing their cash flow/working capital but that few owners of small and medium size business are making use of their existing financial information to help them do this.  How do we reconcile the obvious concern about cash flow management, the benefits from actively managing working capital with the apparent lack of action from owners of small and medium-sized business?

My hypothesis is that business owners are not making use of their financial information to manage their cash flow because they are not confident that they can interpret it properly.  I cannot otherwise fathom how, in a world of sophisticated and affordable accounting software capable of producing myriad reports, business owners are not more actively engaged in managing their cash flow.

The practical lesson from the research, for owners of small and medium size business and their advisers, is if you are not paying attention to the movement in stock, debtors and trade creditors evident in your balance sheet then you are not even beginning to manage your cash flow.  So, if you want to improve your ability to manage your cash flow then as a first step you need to use all the financial information you have at your disposal.  In short, you need to Pay Attention to your Balance Sheet as well as your Profit and Loss Statement.