Small business owners face a multitude of challenges as they struggle to develop their business from infancy to a stabilized operating entity. One of the most critical areas to manage from the financial and operational perspective is cash flow. Following are several strategies that business owners can apply to assist with cash flow management.
Almost all business owners understand the saying “Cash is King”, but many remain unaware of the cash sources and uses within their business. Although many business owners view net income as a cash benchmark, net income provides only a partial picture.
Profit and Loss Statement
The profit and loss statement (“P&L”) provides business owners with an indication of the company’s economic performance. However, unless the books are kept strictly on a cash basis, the reported net income very rarely equals the increase or decrease in cash holdings. (In cash basis accounting, almost all transactions are reflected in the P&L.) Instead, many companies elect to use accrual basis accounting where expenses are matched with sales, regardless of whether cash has been paid out or has been received. The lesson here is that net income does not equal cash.
Prior to receiving any financing, a business typically needs to submit a business plan which provides a road map on how that company will achieve and sustain profitability. The plan identifies sufficient sales volume levels and related expenses. Continuous comparison and adjustment of actual operational revenue and expenses, between the P&L and the business plan, is an effective method of managing cash resources provided by net income.
The balance sheet lists assets owned by the company, liabilities due to third party creditors, and the portion of the assets remaining for the company’s owners. Frequently, the balance sheet is not prepared in conjunction with the P&L, or it is overlooked in favor of the P&L. Unfortunately, control over the balance sheet is a major factor in cash management, so overlooking it can be detrimental.
As unlikely as it seems, a profitable company can become insolvent and result in bankruptcy protection. Cash usage not reported within the P&L, such as significant increases in inventory and receivables, quickly can reduce a company’s liquidity. Following are strategies for managing the balance sheet.
- Cash Account: Keep a running ledger of the cash balance to assess cash levels on a daily basis. Reconcile that ledger with the bank statement monthly, and do not base the company’s cash position assessment on the reported bank amount. However, check bank balances and transactions daily to confirm everything was captured in the ledger. Nothing ruins the business owner’s day like discovering an unexpected bank overdraft.
- Accounts Receivable: The marching order for most business owners is sales, Sales, SALES! If sales are “cash only”, increases are a wonderful thing. However, if the majority of company’s sales are credit based, a gap may exist between the timing of cash receipts and their related cash payouts. If this negative trend continues during a period of significant revenue growth, the company will find itself in a deficit cash position. To mitigate this type of situation-
- Confirm the creditworthiness of all perspective credit customers, if possible.
- Review sales orders daily and ensure invoices are generated.
- Verify that customer terms are properly recorded in the accounting software.
- Review the accounts receivable aging weekly, and contact any customers with past due accounts. Notate the date, customer’s name and payment amount.
- Consider offering a 1% – 2% discount for customers who pay within 10 days or earlier.
- Accept credit cards instead of issuing credit. Credit card settlements are realized by the business within 2 – 3 days, while the customer retains the benefit of not having to pay for 30 – 45 days. Note: There is normally a 2% – 5% transaction fee, plus upfront card processing equipment costs. Ensure that retail prices include these costs using the following calculation: Upcharge Pct = (Expected annual credit card sales / expected total annual sales x transaction fee pct) + (upfront cost / expected annual total sales)
- Inventory: Inventory can increase extremely rapidly if the new business owner cannot accurately predict sales volume or if the business owner is persuaded by high pressure sales reps to forward purchase high quantities at discounted rates. This situation can result in the company having “FISH” inventory (First In, Still Here). To control inventory levels:
- Review the inventory holding areas and notate any excessive holdings.
- Check movement records for slow moving items, and adjust retail pricing to a lower liquidation level.
- Perform a physical count at least twice a year.
- Prepaid Items: Avoid paying a lump sum for items such as insurance and maintenance contracts. Instead, attempt to finance payments throughout the coverage period.
- Fixed Assets: Fixed assets include items for which a useful life exceeds 1 year, such as equipment. A basic financing rule is that fixed assets should not be acquired with cash but rather with long-term debt (unless the company has more than sufficient cash).
- Accounts Payable: The business owner must balance maintaining sufficient cash reserves with maintaining healthy vendor relationships.
- Write checks instead of using ACH payments. If the company is in a “cash crunch”, consider paying vendors with checks. Although the ACH facilitates transaction processing, it shifts cash control from the business owner to the vendor.
- Communication: Contact the vendor if payment cannot be made according to the agreed upon terms, and let the vendor know that payment may be delayed. There is nothing more detrimental to vendor relationships than a communication breakdown. Consider sending the vendor a regular partial “good faith” payment if full payment cannot be immediately made. Remember, Cash IS King.
- Using company credit cards to pay for certain expense items can provide an extra 30 – 45 days to the expense’s normal payment term. Be certain to pay all of the credit card balances by their due date to avoid costly finance charges.
- Review all vendor terms in the accounting application to ensure that vendors are not paid prematurely.
- Taking advantage of a vendor’s early pay discount (ex. 2/10 net 30) provides a significant annual return of 36%, but make certain that sufficient cash reserves are available for this investment.
- Credit Line: Attempt to secure a bank credit line to help bridge gaps caused by balance sheet items that are temporarily out of alignment (ex. AR).
Analytix Solutions has a team of professionals experienced in cash flow planning and management for small to mid-sized companies. For more information on how we may be able to assist your business, please visit us at www.analytixaccounting.com or email us at [email protected].