Over the years from many conversations and consultations I have had with friends, professionals and small/medium size business people, I have come to realize many of them, even who are good and successful at business (ie selling, management, etc) are not so good at Cash Flow Management (CFM) and often in trouble or in stress resulting from that. You may be a good businessman or investor and you may be Asset rich (cash flow poor) but CFM is key to confidently venturing out and then running a smooth operation in terms of business or personal life is good CFM. In this Note I will focus more on CFM as an individual. So what are the key elements and tools of CFM?
Cash Flow can happen in two directions (In or Out). Inflow coming from a Salary, fees, sales, earnings, investments, or any other source are always positive and Outflow stemming from loan interest and capital repayments, salaries (employee), rents, purchases, fees, expenses, Taxes etc. are always negative. Inflows make you richer and outflows make you poorer. They also happen or occur at various points in a continuum or timeline. Some of them occur in a regular, predictable pattern (daily, weekly, monthly, quarterly, semi annually, yearly etc), and others are irregular, at unpredictable intervals or seasonal (December/Avurudu Bonus etc) or can also be a one time windfall.
This pattern or lack of it needs to be studied, mapped out and effectively and creatively managed.
First, Understand the differences or Cash Flow patterns between Assets and Liabilities (Commitments) as well as Income/Expenses and Cash Flow. Assets/Investments (or a set of Assets to start a business) can be financed only by two sources – Your own funds (Equity) or borrowed funds (Debt). An Asset/Investment may or may not (such as a piece of Land) have a periodic Cash Inflow but may eventually give you a large Capital Gain at the time of sale of the Property. Your Salary and Bonuses are positive Cash inflow. If you have Deposit at a Bank or Investment in TBills or Debentures, they give you periodic and fixed positive Cash Inflow. An investment in Stocks may give you both periodic Cash Inflow (Dividends) and a Capital Gain at the time of sale of the Stock. If you buy Assets with no regular or periodic (quarterly/semiannual etc) Cash Inflow ( Ex. Land), or high Cash Outflow (insurance, running, maintenance for Vehicles), you may get into Cash Flow issues. Pay attention to the investments you make and the type of Assets you own;
- Bare Land/Art – only Capital Gains and no cash inflows
- Houses/Apartments/Stocks – both Capital gains and cash inflows (Rent/Dividends)
- Debt Instruments/Fixed Deposits – No Capital Gains but periodic Cash Inflows
Liabilities (Loans or Debt) usually have unavoidable periodic Cash Outflows. Your Credit Card balance, if not paid on the due date in full, has a very high Cash Outflow in terms of Interest they charge. If you take a Housing or Mortgage Loan, that will have a periodic and fixed Cash Outflow (Interest and Capital repayment). Your Vehicle Lease payments are often a huge drain on your Cash position. Your daily, weekly, Monthly living expenses are a Cash Outflow (Reassess to see what can be reduced or cut down).
So take a few hours or days to write down and understand all your Assets and Liabilities and all your sources of income or Cash Inflows and all your sources of Cash Outflows. Also lay them out on a timeline with dates (if known) on which they fall due. This is the starting point of CFM.
Basic objective of CFM is to schedule or manage your cash flow in a manner where your Cash inflows precede your Cash outflows and not the other way around (which also can be managed but at a cost). In other words, you always (or more often than not) have sufficient Cash in your hands or you have access to a ready source of funds to meet your obligations/commitments (cash outflow) falling due at various points in the timeline. However, keep in mind having too much Cash idle (not earning anything even for a day) in your hands is not efficient CFM.
Crunch Scenario – Now understand these expected Cash inflows may not materialize as planned on the due date but assume that your cash outflow on your need to be paid on time. How does one manage such a situation? One way is to have reserves or savings which one can dip into until one reorganizes ones Cash Flow. Or the other path is to arrange a Permanent Over Draft (POD) facility with your Bank which is at a much lower rate than Credit Card Debt if you pledge Collateral (NRFC balance or Land) is a fine way to prepare for this contingency. For small businesses, this may be a mandatory requirement to avoid constant worry and stress.
Strategy I – How does one negotiate or delay paying (cash outflow) on the Liabilities? Or how does one buy some time on your payments? Again POD can come in handy. Or one can borrow from a new source and pay the old debtor to buy time in order to manage the Cash Flow. Or pay your credit card debt on the very last day the payment is due (grace period of 50 days or so).
Strategy II – Try to negotiate Cash inflows (receivables etc.) before their due date. Advance payment on a Sale of an Asset or Product/Service is one such way. Always negotiate an advance payment
Now let me go beyond the above mentioned basics and show you a couple of real life examples (from my own experience as an individual) on how one can be innovative or creative in improving your Cash Inflow (or conversely reducing your Cash Outflow) to illustrate the point. There are many other ways one can come up with once one start thinking or strategizing in terms of improving one’s Cash Inflow/Positive Cash Flow.
- Example 1) I used to have a hefty monthly electricity bill (cash outflow) before I invested Rs. 1.3 mn in a 5 KVA Solar system about 7 years ago. I recovered that investment in 4 years and today my monthly electricity bill is zero despite heavy consumption. I estimate without the Solar system, I would be today paying between Rs. 80,000 to Rs. 100,000 monthly.
- Example 2) I have an NRFC account which use to give me a small dollar interest rate. With recent local and international hikes in interest rates I found out different local banks offer widely different interest rates on NRFC deposits and Over Draft (OD)against it. So I did some shopping around (just find out the rates) and shifted my NRFC to the bank that gives me the best rate on Dollar deposit (upto 9%) and lowest rate on the OD against it, opened an RFC account and shifted my funds there. Took my OD over the counter (one day) in Rupees at 17.5% and invested that money at 30% in a 3 month Treasury Bill. I have clearly improved my income by 12.5% but I must manage my OD interest due end of every month until my T-Bill matures in 3 months. And repeat this back to back Cash Flow matching cycle as long as conditions (Rates) are favorable.
- Example 3) I had a crumbling old house (over 60 years old) on a piece of land which was idling and not giving me any income. I almost demolished the house to sell it for scrap value!!! On second thoughts, I took an OD (Rs. 4mn) at 15% (four years ago) and did a renovation to the house by removing the rooms and making two halls within the house (eliminated all interior walls) which can be partitioned (flexibility) or used in any other manner. With this flexibility and location, I managed to rent the premises with one year rent as an advance deposit which covered my loan. I get Rent as Cash Inflow ever since from this earlier idle asset with no Cash Outflow. Or I could have left the loan unpaid and used the funds from advance Deposit of the Tenant to invest elsewhere and earn a better return than the cost of my borrowing (15%). But synchronizing or managing the inflows and payments due (ie CFM) is a must.
I am sure there are many other real life examples one can cite. Interest Rates and business conditions change all the time and new opportunities will arise. The challenge is to match the Cash Inflows with Outflows in terms of amounts and timing. And have a fall back option when they don’t work out as planned. Or if there’s a short fall or a gap (few days to few months), have a source of Funding or Financing ready. I as an individual or an investor in Sri Lanka have found the POD facility from a Bank against an NRFC or a piece of Land as security the most convenient and cost effective option. Usually on an POD, even if you fail to pay the interest on an outstanding amount in a certain month, the Bank will simply add the interest to next month outstanding amount. So it is a very useful tool to manage your Cash Flow.
So keep your credit history untarnished (don’t default or even delay payments on your liabilities/loans/credit cards, even electricity/phone Bills etc.) and maintain a relationship with a Bank or many Banks. For businesses even their receivables can be used to get financing. One uses it only when there is a funding gap and pays it off no sooner the expected Cash Inflow materializes. POD is not to be used to spend on Consumption (Entertainment, F&B etc.) like Credit Cards. It is only to be used as CFM tool against an expected (but delayed) Cash Inflow from an underlying Asset or Business (Sale, Fee etc.) as a source of emergency financing/funding.
As mentioned in my earlier Notes like this one, discipline in terms of spending/consuming and responsible management of finances are key to achieving financial independence and freedom.
- Identify your current Cash Inflows (Positive or Into your Pocket/Bank Account) and Outflows (Negative – Out of your Pocket/Bank Account)
- Map them out in terms of their Quantities/Amounts and their Occurrence/Timing on a Timeline and identify gaps (specially negative gaps)
- Try to delay the Outflows and try to advance the Inflows where possible and match or synchronize where possible
- Arrange a ready source to use (such as a POD) when there’s a temporary negative gap in Cash Flow (Outflow is greater than Inflow)
- Constantly think and strategize in terms of enhancing or improving your future Cash Inflow and reduce or eliminate your future Cash Outflow.