By Stephen Graham.

When it comes to business, a lock-up isn’t a criminal offence, but it should be.

In my view it is a crime against that most essential of business elements, cash flow. A lock-up means that while you do have cash, you cannot access it yet need it in order to fix or improve cash flow problems.

So how does cash become ‘locked up’? To continue the prison analogy, there are three key crimes that cause a lock-up. One is the debtor (specifically poor debtor management), of which most businesses have plenty and indeed, over the past two years would have seen an increasing trend of more customers taking longer to pay.

The second crime is having too much finished stock on hand awaiting sale. This can be a difficult balancing act as not enough stock may mean lost sales while too much stock will definitely tie up your cash.

Thirdly, having raw materials or work in progress which are yet to become finished stock will lock up cash. And, the longer this transformation process takes, the bigger the problem.  Every business experiences this – even service industries including accountants where client work is delayed to the point where it cannot be invoiced because of hold ups in the job completion process.

To prevent and/or manage a lock up, there are some key areas to focus on.

• Debtors – Focus on selling to your better customers; not necessarily those who purchase the most, but those who actually pay on time!  Poor payers get chased immediately and credit stopped.
• Finished Stock – Improve your stock management to reduce the potential for carrying old or obsolete items and then being forced to fire sell them.  Negotiate better terms with suppliers for delivery, pricing and payment. Ensure you understand your costs so that you are clear about your margins.
• Raw materials or Work in progress – Improve the completion of the transformation to finished stock.  Cash won’t be actually received until these products are turned into finished stock, sold and the customer has paid.

Along with the basic causes of a lock-up, there are many common pitfalls that will escalate problems with cash flow. These range from constantly extending creditors’ payments and missing due dates on priority creditors (such as IRD and loan repayments), to increasingly discounting prices in an effort to move outdated stock. These factors result in losing market competitiveness, bank confidence, internal funds and eventually your ability to execute your strategic business plan.

At a time when banks are crying “cash is King”, knowing how to manage the above mentioned aspects of your business could make for a healthier relationship not only with your bank, but other stakeholders including suppliers, staff and shareholders.

Stephen Graham is a Partner with BDO Rotorua, part of the BDO New Zealand network of independent Chartered Accountant and Business Advisory member firms.
www.bdo.co.nz