Fix Your Flow

Many owners look at profits on the income statement as the defining factor for determining the health of their businesses, but it is possible to show a profit and still be losing money. One of the most overlooked indicators of the health of a business is cash flow. While entrepreneurs are busy closing new customers, engaging new vendors and taking care of the many other tasks necessary to run a business, cash is easily ignored.

To increase the cash in your business, you need to understand what drives your cash flow and shrink your “cash gap.” The following strategies can be implemented immediately to manage the cash in your business and avoid common financial missteps.

Understand What Drives Your Cash Flow

There are a number of useful cash management tools that should be used on an ongoing basis. One of the most important is a cash-on-hand report. This report allows the business owner and executives to know how much liquid cash is available at any given time. Here are some other tools that can be useful.

Short-term cash flow projections can help with managing payables, planning for new purchases and planning for seasonal cash crunches. For example, your bookkeeper hands you the weekly check run. Among the checks is a high-dollar item that, if paid, will put you in overdraft. The short-term cash flow projection can indicate when you can safely make the payment. A short-term analysis will cover between three and 12 months.

Projections analyze payables, receivables, capital expenses, inventory purchases, payroll expenses, utilities, rent and all the other minute details of income and expense on a weekly basis. The report can also analyze in detail the specific day-to-day expenses of the business on a cash basis. Having a clear picture of what is on the horizon will guide you to maneuver your short-term cash policies to meet short-term demands. For example, if you just closed a new account that requires you to purchase a large amount of raw materials, the short-term cash flow will indicate that your expenses over the next few weeks are too high to sustain this outflow until you see a return on that sale. Based on this information you can determine if you should request a prepayment, delay payments to vendors with good relationships, or, if your internal options are exhausted, draw on a line of credit. Most accounting software can produce this report for you, but if you don’t have this option, download a free cash flow projection template from Microsoft at office.microsoft.com/en-us/templates/TC011132361033.aspx.

Long-term cash flow projections can help with planning for expansion, savings and capital expenditures. Using the same data set as a short-term projection, but in a much more general presentation, long-term analysis can cover up to five to 10 years. For example, instead of presenting the electric bill, the water bill and the gas bill separately, the long-term cash flow would present a single line called utilities. In this projection you will estimate the costs of future expenditures based on market conditions and estimate the rising costs of your overhead and products. This report will focus your attention to sales goals and savings goals to meet the rising cash needs for future years.

Product profitability analysis assists in determining which products produce positive cash margins and which ones do not.

Shrink the Cash Gap

Simply put, the cash gap is the time between spending money and collecting money. This gap is usually measured in days. To figure out cash gap, use the following formula: Billing Lag + Collection Period + Inventory Sales Period – Payments Period = Cash Gap (see below).

This information will focus your attention to specific areas of the selling and billing cycles to narrow the gap between money going out and money coming in to your business. To narrow the gap, consider sending out bills as soon as a sale is complete, offering discounts for prepayment or early payment, producing inventory to fulfill orders rather than accumulating stock, and negotiating longer payment terms with your vendors.

This exercise also provides a barometer for measuring cash level improvement. You may also want to consider: