Category SMMEs

Cashing in to help your business survive

27 August 2020 Gys Wilson, Product Head for Guarantees at FNB Business

The importance of cashflow management

Every successful entrepreneur will tell you that ‘cash flow is the lifeblood of every business’, and that without it your business will simply not survive. The effective management of cash flow is essential for any successful business to survive, especially in the current economic environment. It provides a business with the funding it needs to run its day to day operations and help protect it against unplanned expenses.

Entrepreneurs and subject matter experts alike refer to Working Capital during any discussion on cashflow. Working Capital is a term used to describe the measure of funding that is available for a business to perform its day-to-day operations. The funding of Working Capital can be originated from the business itself or through using external funders such as banks.

An effective tool in determining a business’ working capital needs is through a working capital cycle analysis. The working capital cycle refers to the amount of time it takes the business to turn the net current assets into cash flow. Through reducing the working capital cycle, it results in increased cash flow, as the business has improved the efficiency at which it utilises its current assets and liabilities to run the business. The reduction in the working capital cycle can be achieved through measures such as reducing the number of days taken to collect debtors through offering settlement discounts or through extending the terms offered by creditors.

An additional tool available to entrepreneurs requires them to perform a detail assessment of the different expense lines in their business and identify where they can limit the outflow of funds. Through implementing the necessary measures to achieve this, it would then enable a business to deploy the funds elsewhere in the business where they are needed most such as salaries or utilising supplier settlement discounts. Here are examples of some expense lines in the business and their related activities that should be scrutinised further, as they ultimately result in funds leaving the business and placing strain on the cash flow without a return being generated on those funds:

1) Rental of Premises – On origination placing a deposit with a landlord as security for non-payment of monthly rental payments and damage to the property.
2) Electricity expense – On origination placing a deposit with Eskom or Municipality as security for non-payment of monthly electricity accounts.
3) Inventory/ Fuel expenses – On origination placing a deposit with a supplier as security for non-payment of trading account(s).

An efficient and effective solution to each of the above scenarios is using a guarantee issued by a financial institution such as a bank or an insurance company. Through the issuance of a guarantee, the guarantee can replace the deposit with the landlord or supplier, and the deposit can then rather be utilised in a more efficient manner for the business. Depending on the credit position of the business, the deposit could either be invested in an interest-bearing account as security for the guarantee or deployed as part of cash flow relief in the business if other assets are available as security.

Through placing the funds in an interest-bearing account, it will enable the business to earn a return on the deposit which exceeds the inflation rate, thus generating growth in real terms, which is crucial in any economic environment. If the landlord or supplier relationship is for a long period of time, then through the issuance of the guarantee, it will enable the business to significantly benefit from the compound interest effect. This becomes even more significant, given the fact that the landlord or supplier would have offered the business very little interest on the deposit placed with them.

The compounding interest effect is linked to the time value of money and refers to the concept of earning interest upon interest over a period, which ultimately leads to a significantly higher balance. Albert Einstein is often quoted as having said that “compound interest is the eighth wonder of the world…”, and it is this principle which drives many investors to deposit their funds into interest bearing accounts for significant periods of time.

As the global business environment continues to change, entrepreneurs need to ensure they have sufficient cash flow available for their business to not only survive and address unexpected challenges but to also seize opportunities for growth when they are presented. Through the effective management of cashflow and the utilisation of innovative solutions such as guarantees, businesses can achieve growth rates that are superior to their peers and potentially enter new markets previously not considered.

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