The 3Cs of cash management

Imagine a situation where you can see money but cannot touch it.


You cannot touch it because it's simply not there. Mr. Mehra has this problem, which he considers rather unique but the fact is otherwise. He is into business of supplying home furnishings. He would source unique materials and finished goods from around the country and the world. He is very quality conscious and wants to give his end customers the best their money can buy. He knows that his business has the potential to generate a clear profit margin of 30 per cent. This he thinks is the best investment for him and in my view his decision was quite alright.


Mr. Mehra came up with this problem that while he could clearly understand that if he bought something for Rs 100, it would sell in the range of Rs 140 to Rs 150. That's a clear 40 per cent to 50 per cent of gross profit margin.


Deducting his costs (which were variable) he knew that he would be able to make a clear and minimum Rs 30 profit and that's 30 per cent net profit margin.
With his business acumen, he successfully won contracts with many retail chains, malls and supermarkets. But whenever he looked at his bank account he felt he was always left with practically nothing.


Where had his 30 per cent profits disappeared? Something was seriously wrong somewhere but where? This is also quite the situation with many people and it has nothing to do with whether you are in business or in salary.


As and when you look at your bank account, if you are perturbed that there is just not enough money knowing that you earn well then you are in the same situation as Mr. Mehra.


His problem was not only of cash management, as many of you would have guessed. There were in fact four distinct problems viz.,
Cash management was the primary problem. When there is money 'just spend as you like'. This ultimately creates quite a mess and for Mr. Mehra, he would have to pay in 30 days for whatever stocks and material he bought but would only receive his payment in about 90 days.


Business was good and orders were flowing in so he wanted to take advantage of all of them, far beyond his financial means. This is just like a salaried person wanting to take advantage of opportunities to buy things when they are available at a good discount. He started to book new business by taking more credit and at higher costs.


To fund the business momentum he would blindly take loans, use overdraft facility and bear interest cost in the range of 12 per cent to 20 per cent. He could afford to do this as his business was generating a minimum of 30 per cent returns.


This is akin to people taking on large EMI commitments thinking that their high income will always continue.


Blind faith on his customer's payment cycle as he was dealing with very big names.


The 4th issue was the most lethal. The greatest risk is 'What if the payments did not come in time?' if the companies did what he was doing - delay payments to suppliers, take more credit and invest more in own business. He failed to realise that if his business was growing, it was due to the growth of the retailer's business.


As it turned out, the retailer was buying more real estate and thus increased its credit period with vendors giving them very little notice. Mr. Mehra had no choice but to accept a delay of three payments and everything at his end came to a sudden grinding halt.


Now the cost of his debt is mounting each day, he is extremely worried and to the extent that payment of utility bills is also becoming an issue.


In such situations, the most obvious thing people tend to do is to take more loans and that results in entire business profits and many times even the personal capital get consumed to fund debts.


Such problems of debt also happen to many salaried people who buy things to take advantage of short-term benefits and then worry each day about paying expensive loans. If they can't fund the loan they tend to take more loans. Seems like d�j� vu? You are earning well, perhaps really well but no sooner the money hits your bank account it simply gets flushed out.


How can such situations be prevented and salvaged? Frankly, these cannot be prevented as one would always like to grow the business and consume luxuries as well. There is a way to do this and still not suffer. The 3C philosophy must be adopted - Contingency funding, Calculated leverage and Capital division.


You probably know about the first two, here is a bit on what I mean by capital division.


Basically, it is about implementing a discipline by which you separate capital for personal and business/other use. For business owners, this is like having a separate set of cashflows to fund personal/home expenses and a separate set of cashflows for business.


Mixing the two and funding home/personal/children's requirements from the business bank account is where the problem starts. For salaried, this is like allocating a pre-worked set of funds to finance the financial plan and use the rest as is desired. This is easier said than done but once done it can eliminate a multitude of financial issues.


The author, Kartik Jhaveri, an expert at Financial Planning, is a Certified Financial Planner and a Chartered Wealth Manager. He may be reached at [email protected]


Source : moneycontrol

 
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