How to Handle Cash Flow
There’s an old business adage that “cash is king,” and, if that’s the case, cash flow is the blood that keeps the heart of the kingdom pumping. Cash flow is one of the most critical components of success for small or medium-sized enterprises. Cash flow is one of the most vital components of success for small or medium-sized enterprises. A lot of a profitable paper business ended up in bankruptcy because the amount of cash coming in doesn’t compare to the amount of money going out. Firms that do not exercise good cash management may not be able to make the investments needed to compete, or they may have to pay more to borrow money to function.
“Despite the fact that cash is the lifeblood of a business — the fuel that keeps the engine running— most business owners don’t really have a grip on their cash flow,” says Philip Campbell, CPA and former Chief Financial Officer of several companies and author of Never Run Out of Cash (Grow & Succeed Publishing 2004). “Poor cash flow management is causing more business failure than ever before.”
Over the years, academic studies have shown that cash flow problems can be one of the leading causes of business failure. A study reported in August by Equifax, the credit reporting agency, found that between June 2008 and June 2009, bankruptcies among the nation’s 27 million small businesses rose by 81%. While in the U.S. Small Business Administration ( SBA) estimates that approximately 600,000 new small businesses are launched each year, a study reported in the U.S. in 2007. The Bureau of Labor Statistics’ Monthly Labor Review shows that two-thirds will only survive two years, 44 percent will survive four years, and 31 percent will stay for at least seven years. Over the years, Scholars have found that inadequate capital is one of the main reasons for small business failure, coupled with lack of experience, poor location, poor inventory management, and over-investment in fixed assets, according to the SBA.
The following pages will help you understand what cash flow is, how it affects your profits, and tips on how to improve your cash flow.
Cash Flow Basics
What’s the cash flow? It’s basically the movement of money in and out of your business. It would help if you were tracking this on a weekly, monthly, or quarterly basis. There are essentially two types of cash flows:
• Positive cash flow: This occurs when cash flow to your business from sales, accounts receivable, etc. is more than the amount of cash left to your business through accounts payable, monthly expenses, salaries, etc.
• Negative cash flow: This happens when your cash outflow is greater than your cash inflow. This generally causes a business problem, but you can take steps to remedy the situation and generate or collect more cash while maintaining or cutting costs.
Achieving a positive cash flow is not a matter of chance. You’ve got to focus on that. You need to analyze and manage your cash flow to control cash inflows and outflows more effectively. The SBA recommends undertaking a cash flow analysis to ensure that you have enough cash each month to meet your obligations in the coming month. The SBA has a free cash flow workbook that you can use. In addition, most small or medium-sized accounting software packages–such as Quickbooks–will help you produce a cash flow statement. Other websites offer free templates, including Winsmark Business Solutions and Office Depot.
Profit versus Cash Flow
Achieving a positive cash flow is not a matter of chance. You’ve got to focus on that. You need to analyze and manage your cash flow to control cash inflows and outflows more effectively. The SBA recommends undertaking a cash flow analysis to ensure that you have enough cash each month to meet your obligations in the coming month. The SBA has a free cash flow workbook that you can use. In addition, most small or medium-sized accounting software packages–such as Quickbooks–will help you produce a cash flow statement. Other websites offer free templates, including Winsmark Business Solutions and Office Depot. “Profit, as defined in the accounting rules, is simply revenue minus expenses. Invoking a customer for products or services that you have sold to them creates revenue. In fact, collecting money on that invoice is what creates cash.”
Positive cash flow is needed to generate profits. You need enough cash to pay for your employees and suppliers to make the goods. It’s the sale of those goods that helps to make a profit. But if you don’t have the money to make the goods, you’re not going to end up with the Profit. So you need to structure your business to have a positive cash flow if you want your business to grow and increase profits.
“Growing your business puts a huge strain on cash,” said Campbell. “You almost always have to make investments and make certain expenses ahead of the increase in revenue and cash flow that comes with successful growth. Perhaps you want to open an office in a new city to build a business there. Or, you need to build a new facility so that you can sell to larger customers.
How to Improve Cash Flow
Most business owners see growth as a solution to the problem of cash flow. That’s why they often achieve their goal of growing a business only to find that their cash-flow issues have increased in the process. Growth plan and the related cash outlays in advance, so they don’t come as a surprise. In the meantime, the SBA recommends that you take the following practical steps to better manage cash flow, especially for growing businesses:
Collecting receivables – To speed up the receipt and processing of receivables, the SBA proposes several steps. Spring for a lockbox service, post office boxes serviced by banks so that customers in remote locations can post payments there, and the checks will be processed more quickly by the banks. Ask customers to pre-authorize checks so that banks can draw on their accounts in a timely manner. Centralize your bank to one bank. Ask customers to pay with depository transfer checks, a relatively cheap transfer of funds. You can also try offering discounts to customers by paying bills quickly.
Tightening credit requirements – Businesses often have to extend credit to customers, particularly when starting out or growing. But you have to do your research beforehand to determine the risk of extending credit to each customer. Can they pay their bills on time? Is their business growing, or is it faltering? Are they having problems with cash flow? The SBA recommends receiving a Dun & Bradstreet report on potential customers and asking them to complete a credit application. You should check the references, too. Another option for extending credit to stores is to accept credit cards. This will cost you a percentage, generally from 2 to 5 percent of sales, but it may be a safer bet to get paid on time
.Increasing sales– -If you need more dollars, it would seem like no brainer to go out and attempt to draw new customers or offer additional products or services to your current customers. Yet this could be better said than achieved. New consumer acquisition is vital to a growing market, but it can take time and resources to turn opportunities into revenue. Selling more to current clients is more manageable. You might be able to do so by understanding what they are purchasing and the why-information that could also help you raise your profit margin and, potentially, produce more revenue. But the SBA advises companies to be vigilant when their profits, so you can only increase their accounts receivable and not the real cash If the purchases are on credit.
Pricing discounts– One way to maximize cash flow is to give the consumers incentives if they pay early. Although this strategy may affect your profit margin, it can improve your cash flow management by motivating consumers to make payments faster than regular billing periods entail. Your companies can also take advantage of this for the vendors and those you owe, but be mindful that the early interest payments do not leave you with a cash flow deficit.
Securing loans– Short-term cash flow issues can often cause a company to borrow from a financial institution. Any alternative forms, according to the SBA, are revolving credit lines or equity loans. Most of the time, this financing method achieves its targets, but many banks canceled credit lines and made loans after the financial crisis. Another alternative is a long-term amortized loan that requires interest and principal before the debt is paid off.
Getting Control of Your Cash Flow
Campbell advises asking yourself the following two questions to get a feel of whether your business ‘ cash flow situation is under control:
1. What’s my cash balance right now?
- What do I expect my cash balance to be six months out from now?
“If you can’t answer these two questions, buckle yourself in for a crazy ride,” he says. “You’re on a roller coaster trip that’s about to get extremely scary. You’re not in control of your cash flow.”
One way to keep this situation under control is to check your cash flow results every month to see how your management is generating the kind of cash flow that your company wants. It also makes you get better and better at making cash flow forecasts that you can focus on when you make financial decisions to grow your business and take care of your current bills.
