Amazing as it may seem, those responding to a National Federation of Independent Businesses survey, published in June 2004, did not list cash in the top five of small business worries. It may have been close, at number seven, but it didn’t make the top five, all five of which we have already discussed.

While not listed in June 2004 as a top five worry, the fact that cash flow was even in the top 10 of small business worries should give all businesses some level of concern. You may ask why this is, followed by an internal sigh as you realize we will probably answer the question. The reason larger businesses should be concerned by their littler siblings in the business world can be summed up in a few words. Think of the consumer as the microscopic plankton used to feed their larger cousins, the minnows. The minnows are eaten by fish; fish by sharks, sharks by people and so on. If the minnows (small business customers) don’t feed (pay) the larger fish (companies) and so on, soon, the whole food chain is in chaos and everyone is starving.

Having seen enough larger fish...errr...businesses bankrupt because the minnows did not pay them, we can tell you the analogy is fairly accurate. So, how do you manage to remain alive when the plankton or minnows don’t pay? More importantly, how do you keep the plankton and minnows in the current category instead of in the past due accounts? How do you make sure you have enough cash on hand to insure that a temporary cash problem at one of your minnow’s places of business doesn’t become a major problem for you? Let’s take a look.

First things First!

While most people reading this article will know many of the following definitions, they bear repeating for those who are new to the cash management game.

• Account receivable is your customer’s promise to pay you within a certain period after you have transferred title to your inventory to the customer (i.e. a sale).



• Account payable is your promise to pay a vendor for providing you with products, services and supplies.



• Cash management is the active management of cash inflows and outflows to achieve the maximum return from investments made from normal cash resources.



• Current or short-term debt is debt that must be paid within a year from the date of your balance sheet. For our purposes, this includes accrued expenses that are generally due in a very short period of time (one month or less in many cases).



• Current assets are assets you expect to convert into cash or otherwise use up within one year.



• Long-term assets are those you expect to convert into cash or otherwise use up in greater than one year.



• Long-term debt is debt that is not due until the passage of one year or longer.



• Operating cycle is the time it takes to convert one sale-account receivable into cash and one account payable into a paid expense.

Basic Cash Management

At its simplest, cash management is the art of managing your cash so you can pay your bills as they come due. That’s pretty basic, isn’t it? Let’s throw you a curve. How easy is it to manage the cash and pay the bills when you have to wait 30-45 days before your customer pays you for the product they bought? Still pretty simple? Ok, let’s add that you have employees that must be paid weekly and suppliers that have you on C.O.D. because you are new? Now, cash is getting pretty tight if you don’t have a source of cash other than sales. Again, from experience, employees don’t like to wait 30 days for their wages and C.O.D. shipments don’t stay at your business if you don’t pay on delivery.

No business is immune from cash crunches, but most could avoid the crunches if they would better manage their cash. This means they must plan for contingencies like bad debts, C.O.D. vendors, slow sales and other cash killing events. So, how do most companies cope?

The Right Mix of Resources

Perhaps the single most important advice a start-up business can follow is: expect problems. Many new businesses assume that sales are going to be great and cash will flow quickly from those sales. In the retail environment, cash will flow quickly from the sales, but it’s hard to establish a business and even harder to get the customers and sales creating the cash. Most new, and many old, small businesses tend to be too optimistic on the expense side also. The fix for this is to be cautious in your sales forecasting and cash collections (i.e. if you think real growth will be 10%, forecast 5%) and be very liberal with your expenses forecasts (i.e. if you think expenses will increase 5%, forecast 7.5%). If you are living out of your business, which is a probability, be certain to include in your forecasts your living expenses and what resources you already have.

Now that you have an idea of what your cash needs will be, design a cash budget that will provide you with enough cash on hand, in short-term liquid investments or in credit facilities, to pay for at least six-month’s of both business and personal operating cash. This is the minimum working capital you should have on hand at any one time. Six-month’s is the minimum if you are operating during good economic times. If you are operating in a tough economic environment, you may wish to increase your cushion to 9-12 months.

The design of the cash budget will need to include various considerations and assumptions. This month, let’s look at the assumptions about cash sources.

• Cash and credit sales - Assuming they aren't deeply discounted, cash sales, including check and credit card, are just about the best sales you can have from a cash flow perspective. You make the sale and you receive payment immediately with a low possibility of a bad debt. Credit sales are a bit trickier because you have to wait for the cash to come later. Not only that, you often must remind the customer they owe you money. This leads to a real potential for bad debts, which means you must investigate the customer’s credit history before extending the credit. Nothing will mess up your cash flow faster than a bad debt on a big sale.



• Investor capital - How much cash/capital do you personally have to put into the business? Will this be enough, or should you expect to need cash from other financing resources? Should you borrow extra money needed or should you look to outside investors? One rule to remember is that cash put into the business in the form of equity is not likely to be your cheapest money. Owners will, generally expect a much greater return on their money than a bank will. That’s because banks generally have collateral backing their loans while investors are the last to be paid in a bankruptcy.



• Bank loans - Bank loans come in two varieties. Unless you already have enough cash, you will probably need both types. Use long-term debt to finance long-lived assets like building, equipment and other property with a life greater than one year. You finance fixed assets like these with loans that are repaid over several years because you know that the return on long-lived assets isn’t received in one year, so you must match the payments on the loan to the cash coming in from your investment. Use short-term debt to finance short-term assets. You expect to turn these assets into cash in a short period, so you will be able to repay the debt. Too often, businesses take the cash from a short-term line of credit and buy equipment or distribute the money to owners. This can be lethal to the business.
  
  Remember also that no bank is going to lend you money based on 100% of your receivable or inventory balance. Banks use guidelines that take into account the use of your inventory, age of your receivables and many other variables to set your borrowing base, which is the sum of those assets on which the bank will lend you money.



• Other sources - If you generate a significant number of accounts receivable, or high dollar receivables, you may wish to investigate factoring your receivables. These can be good capital sources if their use will allow you to take advantage of purchase discounts or if the factors will take your debt on a no recourse basis. This means the factor will not make you return the cash if a customer defaults on a loan. Without intending any puns, while this financing tool is right in many cases, you must take into account all factors before deciding to factor your receivables.



• Venture capital - Venture capitalists generally loan money on big startup projects in exchange for ownership in the company plus a return of their capital. This is very expensive money, but sometimes it is the only way to finance extremely expensive endeavors.

Conclusion

Managing your cash flow is critical to your success. Since man invented money, cash has been king as far as the business world is concerned. For many businesses, cash is a constant problem; a problem only good budgeting and forecasting, along with solid financial backing, will cure. Are you having cash flow problems? Before you head to an attorney to file bankruptcy, give us a call. Let us help you find other ways, if possible, to manage your cash needs without harming your reputation with vendors and customers. We are here to help and truly have your best interests at heart.

Have a great August and may your cash truly flow in to you, instead of out to your creditors.