All companies go out of business for the same reason: they run out of cash. This does not always mean that sales or profits were down. Instead, the company simply did not have enough cash in its operating account to pay its employees and other vendor bills. This typically happens because the small business owner is so focused on sales growth or profitability that he or she forgets about cash. They reason that if the business has sales, it also has to have cash. Unfortunately, this is wrong.
The small business owner may review the profit and loss statements or balance sheets, but never take a look at the monthly cash flow statement that tells him or her if available cash is growing or shrinking.
It was reported in the presidential election of 1992, that James Carville, Bill Clinton’s campaign manager, had a sign posted in their Little Rock Office that simple stated “It’s the economy, stupid.” This was a reminder to everyone that worked at the campaign that the only issue that mattered was the economy. That year, I started my third business after failing in two others. This time, I made my own sign and tacked it up in my office. It read “It’s cash flow, stupid.” It became my daily mantra.
Cash is the gasoline that makes every business engine run. In financial terms, cash flow is defined as cash receipts minus cash payments received over a given period of time. It’s the flow of money in and out of the business that essentially determines the business’ health. Remember that sales are vanity and cash flow is sanity.
So Where Do You Start?
First, have an accountant or bookkeeper construct a cash flow statement monthly. Most accounting software packages have a standard report that will produce a statement in its most basic form. Learn what every positive and negative number on the statement means. If this is too difficult, look at your company’s major operating account statement; does it have more or less cash at the end of the month than at the beginning?
Once you understand your report, then it’s time to pick up the cash flow pace. Collecting accounts receivables faster will increase cash. Getting longer payment terms or increased credit from vendors will also boost cash. Selling inventory faster and keeping inventory levels lower will also accomplish the same thing. Remember that buying inventory that only sits on the shelves for months waiting for customer orders can take a lot of unseen cash out of the business.
Here are more simple ideas to bring more cash into any business:
- Get customers to pay with credit cards at the time the product or service is delivered. This way, the business gets money it can use in its checking account over the next few days instead of waiting 14 to 60 days to be paid.
- Give customers discounts for paying their bills sooner. With interest rates low, offer a half percent discount for paying within 10 days. Some large corporations actually have account receivable auctions where they pay sooner for even a 0.1% discount.
- Ask customers to pay a deposit—or in advance—for services before they are performed. This has become an industry practice in many companies, and many consumers now expect this option.
- Bill customers as soon as the service is performed or the product is delivered. Don’t wait until the end of the month to send them a statement. While weekly billing many be more costly to administer, it can bring up to 21 days of additional cash.
- Be diligent about collecting accounts receivables. State a specific date that the payment is due. Do not use “upon receipt” because the customer then has the tendency to set their own date. Call soon after the bill is sent out to make sure they received it and ask when it will be paid. Follow up early and often. Every business has the right to be paid within terms, so don’t be timid about asking for the money.
- Pay vendor bills after 30 days with credit cards. This gives 30 more days to pay until the credit card bill comes due, typically with no interest fee.
- Track inventory carefully. Know what sells quickly and what never moves off the shelves. Know how long a customer will wait for a product and still be satisfied. Set reorder points and reorder quantities carefully.
Remember that every business runs on cash and it is the business owners’ responsibility to make sure that their tank is always full.