How Businesses in California Can Acquire and Keep a Positive Cash Flow – July 17, 2018

As the saying goes, “cash is king!”  Cash flow is the lifeblood of any business organization. Small-business owners are often so concerned with other matters that they fail to pay proper attention to managing their cash resources properly.

More businesses go out of business for this above all other reasons. The hard reality is this – When you’re out of cash, you’re out of business. The fortunate thing is that proper cash management, like many other skills, can be learned.

Once understood and implemented, you will wonder how you got along without using “cash management” as an integral tool in managing your small business.  This chapter will show you how.

What is Cash Flow?

Cash flow is the movement of money in and out of your business over a period of time; these movements are called inflow and outflow. Inflows for your business primarily come about from the sales of goods, collections of your receivables, borrowed money, investment income from interest, and finally, sale of assets.

Outflows for your business are measured by the checks you write and the cash you disburse to pay expenses. Some examples of cash outflow are payroll, operating costs such as utilities, rent and telephone, purchasing inventory, and any loan repayments.

A positive cash flow results if the cash inflows are greater than the cash outflows. A negative cash flow results when the opposite takes place; cash outflows exceed cash inflows.

Cash Flow Verses Profit

Although cash is critical, people think in profits instead of cash. We all do. When you imagine a new business, you think of what it would cost to make the product, what you could sell it for, and what the profits per unit might be. We are trained to think of business as sales minus costs and expenses, which are profits. Unfortunately, we don’t spend the profits in a business. We spend cash.

Profitable companies go broke because they had all their money tied up in assets and couldn’t pay their expenses. Working capital is critical to business health. Unfortunately, we don’t see the cash implications as clearly as we should, which is one of the best reasons for proper cash planning. We have to manage cash, as well as profits.

Cash flow and profit are two concepts that are very different from each other and very often misunderstood by many small-business owners. The two major differences between cash flow and profit come about due to:

  1. Difference in timing when transactions are recorded. Profits are the excess of revenues over expenses. Revenues are recorded in the books when your customers buy from you, with cash or on credit. Even though you haven’t received the cash, the sale shows up on your income statement and is part of your profits (assuming you are on the accrual basis). As part of your management review, if you were to look only at your income statement for that period of time, you’d think all was well because your books are showing a healthy profit. Your cash flow statement, however, shows a very different picture. This difference between when a sale is made and the cash is received can have serious financial consequences on your business if not understood and reviewed regularly.
  2. Type of transactions that are used when computing each one. The second important difference between cash flow and profit is the type of transactions included in each. Cash flow considerations include items such as funds borrowed, equipment sold, and loan repayments. These items don’t figure into profits and don’t show up on your income statement. But such items do have a significant impact on your cash flows. Likewise, there are other items such as depreciation which are not considered when computing cash flow but do play an important role when computing profit.

Practicing Proper Cash Management

Proper cash management can contribute much to the success of your small business. Cash makes business owners’ dreams come true! Managing your cash well means making the best, most productive use of what you have.   It involves knowing the following: 1) what your cash needs are; 2) when, during the year, you generally need cash; 3) the best sources for meeting additional cash needs.

Proper cash management also means you must be prepared to meet needs when they occur. The quality of relationship you maintain with bankers and creditors will go a long way towards determining your supply of cash.  Equipped with the necessary financial statement tools in hand (the cash flow statement, the cash projection and the variance report), you are ready to maximize the cash in your business.

What happens when your cash needs outpace your cash available?  The answer is clear – it is difficult, if not impossible, to plan for the future!  Even some of the best-managed companies may find themselves vulnerable to cash shortages.  Adding employees or inventory too rapidly is one way in which this can occur.

These ideas can provide relief and positively influence your cash flow:

  1. Bill promptly: Prepare invoices immediately after you have delivered your goods or services to each customer. Once the invoice has been prepared, be sure it is sent immediately to the customer.
  2. Payment in advance: A number of businesses require payment in advance for some part of the sales price, and often encourage up-front payment with a substantial discount. This leads directly to cash in the bank.
  3. Collect on your accounts receivable: If you do nothing else, make certain that your credit-and-collection system is operating at peak efficiency.
  4. Trim your Inventory: Inventory describes the extra merchandise or supplies your business keeps on hand to meet the demands of customers. Keeping too much product on hand can tie up a great deal of cash. Too many business owners buy inventory based on hopes and dreams instead of what they can realistically sell. Keep your inventory as low as possible.
  5. Accounts payable: Accounts payable represent amounts you owe to your suppliers that are payable sometime within the near future. In this case, “near” probably means between 30 and 90 days. To maximize the flow of your cash, you should speed up collection of your receivables, but slow the payment of your bills.
  6. Minimize Expenses: The absolute best way to improve your cash flow, and in particular to improve your accounts payable, is to minimize your business’ operational expenses and ensure you make the most efficient use of every dollar you spend.

Cash is king.  Simply put, “no cash equals no business.” It is the gas that keeps your business going.  As the owner, you must know how much cash comes in and how much goes out on a regular basis. Companies go out of business for cash flow problems over profitability.

Even otherwise-healthy companies can go under for lack of cash. It can kill a company if it sneaks up by surprise, but can be easily managed when there is a plan for it. Tracking the amount of cash you have is a vital function that you can never lose a handle on.

For more on this topic, please check out my book “Secrets of Small Business Success in the San Francisco Bay Area“.