By Nwaodu Lawrence Chukwuemeka
From the basics, to tips on how you can improve cash flow, here is everything you need to know about cash flow management. Cash flow is one of the most critical components of success for a small or mid- sized business. Without cash, profits are meaningless.
There’s an old adage about business that “cash is king” and, if that’s so, then 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 a small or mid-sized business. Without cash, profits are meaningless. Many a profitable business on paper has ended up in bankruptcy because the amount of cash coming in doesn’t compare with the amount of cash going out. Firms that don’t 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 truly have a handle on their cash flow. Poor cash-flow management is causing more business failures today than ever before.
Academic studies over the years have found that cash flow problems can be one of the leading causes of failure for businesses. A study reported in August from Equifax, the U.S. credit reporting agency, found that bankruptcies among the nation’s 27 million small businesses leaped by 81 percent between June 2008 and June 2009. While the U.S. Small Business Administration (SBA) estimates that about 600,000 new small businesses are launched each year, a 2007 study reported in the U.S. Bureau of Labor Statistics’ Monthly Labor Review indicates that two-thirds will only survive two years, 44 percent survive four years, and 31 percent survive for at least seven years. Scholars have found over the years that insufficient 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 will help you understand what cash flow is, how it impacts profits, and tips on how to improve your cash flow.
Cash Flow Basics –
What is cash flow? It’s basically the movement of funds in and out of your business. You should be tracking this either weekly, monthly or quarterly. There are essentially two kinds of cash flows:
- Positive cash flow: This occurs when the cash funneling into your business from sales, accounts receivable, etc. is more than the amount of the cash leaving your businesses through accounts payable, monthly expenses, salaries, etc.
- Negative cash flow: This occurs when your outflow of cash is greater than your incoming cash. This generally spells trouble for a business, but there are steps you can take to remedy the situation and generate or collect more cash while maintaining or cutting expenses.
Achieving a positive cash flow does not come by chance. You have to work at it. You need to analyze and manage your cash flow to more effectively control the inflow and outflow of cash. The SBA (Small Business Association) recommends undertaking cash flow analysis to make sure you have enough cash each month to cover your obligations in the coming month. The SBA has a free cash flow worksheet you can use. In addition, most accounting software packages geared to small or mid-sized businesses – such as Quickbooks, Peachtree, etc, will help you produce a cash flow statement. There are also other websites offering free templates, including Winsmark Business Solutions and Office Depot.
Profit versus Cash Flow –
Profit does not equal cash flow. You can’t just look at your profit and loss statement (P&L) and get a grip on your cash flow. Many other financial figures feed into factoring your cash flow, including accounts receivable, inventory, accounts payable, capital expenditures, and debt service. Smart cash-flow management requires a laser focus on each of these drivers of cash, in addition to your profit or loss. There is a secret that very few business owners have discovered (and the accounting community has not done a good job revealing): knowing whether you earned a profit (or created a loss) is not the same as knowing what happened to your cash. Profit, as defined by the rules of accounting, is simply revenue minus expenses. Invoicing a customer for products or services you sold to them creates revenue. Actually collecting the money on that invoice is what creates cash.
A positive cash flow is actually needed to generate profits. You need enough cash to pay your employees and suppliers so that you can make goods. It’s the sale of those goods that helps generate a profit. But if you don’t have the money to make the goods, you don’t end up with the profit. So you really 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. You almost always have to make investments and bring certain expenses on ahead of achieving the higher revenue and cash flow that comes with successful growth. Maybe you want to open an office in a new city so you can build the business there. Or, you need to build a new facility so you have the capacity to sell to larger customers. Those scenarios (and others) require cash up front.
How to Improve Cash Flow –
Most business owners see growth as the solution to a cash-flow problem. That’s why they often achieve their goal of growing the business only to find they have increased their cash-flow problems in the process. Plan for growth and the related cash outlays in advance, so they do not come as a surprise. In the meantime, the SBA recommends that you take the following practical steps to better manage cash flow, especially for the growing business:
- Collecting receivables – To speed up the receipt and processing of receivables, the SBA suggests several steps. Spring for a lockbox service, post office boxes serviced by banks so that customers in far flung locations can mail payments there and the checks will be processed by the banks more quickly. Ask customers to preauthorize checks so that banks can draw against their accounts at timed intervals. Centralise your banking at one bank. Ask customers to pay with depository transfer checks, a relatively cheap fund transfer. You can also try offering discounts to customers if they pay 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 faltering? Are they having cash-flow problems? Like in the U.S. the SBA recommends getting a Dun & Bradstreet report on potential customers and asking them to fill out a credit application. You should also check references. Another option to extending store credit is to accept credit cards. This will cost you a percentage, generally from 2 to 5 percent of the sale, but it may be a safer bet for getting paid on time.
- Increasing sales – If you need more cash, it seems like a no brainer to go out and try to attract new customers or sell additional goods or services to your existing customers. But this may be easier said than done. New customer acquisition is essential to a growing business, but it can take time and money to convert prospects into sales. Selling more to existing customers is cheaper and you may be able to do this by analysing what they’re buying and why – information that may even lead you to increase your profit margin and, hopefully, generate more cash. But the SBA warns businesses to be careful when increasing sales because you may just increase your accounts receivables and not actual cash if these sales are on credit.
- Pricing discounts – One option to increasing cash flow is to offer your customers discounts if they pay early. While this practice may impact your profit margin, it may help your management of cash flow by incentivising customers to make payments earlier than billing cycles typically require. Your company may also take advantage of this with suppliers and others that you owe, but be careful that your early payments of debt don’t leave you with a cash flow shortfall.
- Securing loans – Short-term cash flow problems may sometimes necessitate a business taking out a loan from a financial institution. Some possible types are revolving credit lines or equity loans, according to the SBA. Most of the time this type of borrowing accomplishes its goals, although during the financial crisis many banks were canceling credit lines and calling in loans. Another option is a long-term amortised loan which includes interest and principal until the loan is paid off. A loan from the cooperative society or the microfinance banks might be apt for this purpose.
Getting Control of Your Cash Flow
Ask yourself the following two questions to get a sense about whether you have your business’ cash flow situation under control:
- What is my cash balance right now?
- What do I expect my cash balance to be six months from now?
If you can’t answer these two questions, then strap yourself in for a wild ride. You are on a roller coaster ride that’s about to become really frightening. You don’t have your cash flow under control.
One way to keep that situation under control is by tracking your cash flow results every month to determine if your management is creating the type of cash flow your business needs. This also helps you get better and better at creating cash flow projections you can rely on as you make business decisions about expanding your business and taking care of your existing bills.
Monitor your cash flow regularly. Cut costs. Cash in on assets. Get a business line of credit before you need one. Lease equipment instead of buying it. Stay on top of invoicing. Don’t let travel slow your invoicing. Get paid faster by using mobile payment solutions, and you will be fine.
Nwaodu Lawrence Chukwuemeka (Ideas Exchange Consulting). nwaodu.lawrence@hotmail.co.uk (07066375847).
