Cash flow refers to the infusion of cash into your business and its subsequent utilisation. A company’s cash flow is calculated by examining cash levels at the beginning and end of each month’s accounting period. When it is gauged at the beginning of the monthly accounting cycle it is called the ‘opening balance’; at the end it is the ‘closing balance’.
It is the business equivalent of an individual’s income. Just as employees use their salaries to pay their rent and utilities, a business draws on its reserve of hard money, to pay salaries and meet administrative and operational costs.
At the end of the day, every business has to balance its budget; this involves calculating employee productivity vis-a-vis revenue generation, and comparing it to the cost of employment. This is a sound business practice, and should be part of a broader stock taking exercise. Here are a couple of things you need to consider when it comes to cash flow management, and as you try to determine the cash flow-employee compensation situation.
Examine your current pay and benefits structure. An SME’s employees are its most critical resource. Some big businesses are infamous for their uneven pay scales and high attrition rates, but even they have to focus on nurturing a core set of employees. This might be to the detriment of their warehouse staff, for example, who continue to receive minimum wages instead of an income, their poor compensation subsidising the pay of top tier employees.
Such a dubious approach is not available to SMEs, and in the long run, abysmal pay is both a weak business strategy and unethical to boot. So, employee salary is a critical cash outflow component.
Product market or labour market? When it comes to cash flow calculation, there are two different ways to look at the ratio of labour cost to total cost. In the product market approach the average cost of labour, elasticity of demand, and uniqueness of employee skill-sets determine compensation levels; companies tend to take the labour market route in industries in which limited employee availability, high cost of hiring, and a low retention-quotient are the defining factors.
In the second scenario, a company would prioritise employee loyalty when determining job salaries, thus ensuring that compensation was high when compared to the market average.
Compare current wages to present and future operational costs. If one adopts the labour market perspective, which places human resources high up on the list of non-negotiable operational expenses, then one has general sense of how to go about the cost comparison process. Even so, if you were to find that the ratio is heavily skewed towards employee compensation, and that you were paying your workers too much, you could reduce their pay.
However, before you did this, you would have to take into account projected cash flow as well. In the context of future net income, your current payment structure could come across as proportional. Determining whether your employees’ salaries are ‘eating into’ your overall cash flow is not an easy or value-neutral exercise. It depends in part on the type of industry you’re in, as well as your overall employment ethos.