Whether you’re looking to harness or secure new client opportunities, promote staff growth, rebrand for marketing purposes or simply upgrade to a larger office, it is going to be difficult to do so without sufficient cash flow or access to external cash injections.
It is for this reason that many accountants use the adage “cash is king”; without positive cash-flow in the present, future growth can sometimes be tricky.
The implication is that business owners should constantly be looking for new ways to improve their business efficiencies, especially in the post-GFC era, where the impetus to protect one’s bottom line has become even stronger.
One of the most central, but not widely understood, business efficiency concepts is that of ‘lock up’; that is, the average amount of days that it takes for a business to convert stock and work in progress into cash.
Why is it important for business owners to understand the ‘lock up’ concept? Because through analysing their business’ lock up period, an owner can pinpoint strategies for more efficiently converting stock and work in progress into cash – strategies which, if implemented effectively, can improve profits and cash flow, and enhance a business’ ability to pursue future growth prospects – all because the business would then be turning over money more quickly within a 12 month period.
There is a quick and simple way for a business to calculate its lock up period: divide the value of debtors and work in progress by annual revenue and then multiply this percentage by 365 days.
For example, a firm that has an annual income of $10 million and current debtors and work in progress of $4.5 million has a lock up period of 164 days.
During that time employees, contractors, landlords and various other stakeholders will need to be paid, requiring immediate cash flow. If the firm was able to reduce its lock up from 164 days down to 100 days, it would improve its cash flow by $1.8 million.
In terms of assessing and reducing a business’ lock up period, there are several strategies that a business can look to employ.
The first step that I would recommend for any owner is to develop a strong understanding of the lock up concept and how this can affect their business. In this respect, proactive research and professional advice from a qualified accountant can be invaluable.
To build on this, an owner may want to consider downloading a CFO digital dashboard from the internet; these types of software are easily accessible and can show not only how many lock up days their business has, but also the variables that went into calculating that figure.
Having done that, I would then encourage the owner to start looking closely at holistic strategies for increasing their business’ efficiencies. To this end, a number of procedural changes could be implemented depending on the nature of the business in question.
A service-based business owner, for example, should look to increase the certainty, efficiency and regularity of their invoicing processes.
This may involve discussing interim billing options with clients or asking clients whether they’d object to being invoiced ahead of time.
While many businesses expect that their clients will be unreceptive to the prospect of up-front payments, it’s not uncommon for clients to welcome such; by invoicing at the beginning of a job rather than at the end, the client knows exactly what to expect in terms of fees, which can help them to better plan their own cash flow and pay invoices more quickly.
Goods-based businesses, on the other hand, will require efficiency strategies with a greater focus on stock selling processes.
For example, an owner may look to reduce their stock levels at certain points in time or increase their emphasis on business turnover and sales.
The importance of business owners having a hold on ‘lock up’ ties into the broader concept of SME owners becoming their own Chief Financial Officers (CFO).
Most SMEs cannot afford to employ a CFO and, as such, it is becoming increasingly important for owners themselves to have a strong understanding of key accounting fundamentals.
For more information on how you can reduce your business’ lock up days or more effectively manage organisational growth, make contact with a qualified accountant; with a professional by your side, it can be much easier to navigate the sometimes murky waters of business expansion.
Pierre Wakim is a partner at leading Western Sydney accountancy and business advisory practice, Younis and Co. He has more than 10 years’ experience working with owners to grow enterprises. Visit www.younisco.com.au
