Cash Flow Management

Many entrepreneurs and small business owners have great business ideas and this is reflected in their products and services. These great business ideas are mostly sound but lack one very important element of good business strategy — Cash Flow. Many businesses fail not because their ideas are flawed but they just could not maintain their Cash Flow well.

Cash flow management is a problem for almost any firm, large or small. The worst symptom of the problem: the business runs out of cash. Watching a business floundering, running out of cash even as it makes great sales and profits is painful. Painful though it may be, it is common and repeatedly the cause of business failure.

Small businesses are especially vulnerable to cash flow problems since they frequently operate with inadequate cash reserves or none at all and, worse, tend to miss the implications of a negative cash flow until it's too late.

Any good business plan must provide you with a reasonable forecast or estimation of the breakeven point. Even it may take time before breakeven point can be met you should at least ensure that you have available cash on hand to sustain the business throughout its life. Cash Flow must be maintained at a comfortable level at all times. By comfortable, I mean it should be at least more than 2 to 3 months of your total expenses and sales costs.

For financing purposes, cash flow projections are generally the most crucial aspect of the business plan. Bankers and other outside financing intermediaries will almost always look for a cash flow analysis in preference to any other financial statement, because this will show how the loan can be repaid. In larger companies, the cash budget for a new project or expansion is critical to the overall decision to commit funds and move forward.

Timing and cash flow are inseparable. Payments to suppliers are typically expected often even before customers of the business pay their bills. As a result, the operation is very likely to have a negative cash flow when it grows dramatically. Periods of change are always reflected in an altered cash flow. If sales fall off, the cash flow slows down. Interestingly enough even if sales increase, the cash flow may stop completely or even become negative (more out than in). Think of the impact of credit sales on cash flow, for example. One-time events such as population shifts or changes in competition could trigger such consequences. More commonly, seasonal fluctuations of the business may also pose cash flow problems where a build-up of inventories must precede the sales cycle (such as a toy business prior to the Christmas holidays).

Whatever the cause, the underlying message is simple: Run out of cash and the business is in trouble. Even if it is possible to raise more money from other sources, sooner or later the timing of cash inflows must match the outflows if the business is to survive.

Why is cash flow so important? If the cash inflows exceed the cash outflows, the business can continue operations. If the cash outflows exceed the inflows, the business RUNS OUT OF CASH and grinds to a halt. Even if the imbalance is only for a short period, it can spell disaster.

Cash flow management does not need to be mysterious or complex. Managing cash is all about timing the inflows and outflows. Cash Flow Analysis starts the process. This can be as simple as going to your check book or accounting system and analyzing your receipts and disbursements over the past few months. A pattern is likely to emerge. What are the revenue sources, and how consistent are they from month to month? As well, what are the expenditures, and how repeatable are they from month to month? Next, look at the incoming revenue stream (Accounts Receivable) or your sales forecast to confirm and further predict cash inflows, and your Accounts Payables to build a pattern of required future disbursements. Match the two. Is there a positive or negative cash flow?

If there is a negative cash flow, the deficit needs to be covered from somewhere. There are two options. Spend less, or get more revenues. Even it the cash flow is positive, inspecting the individual elements may further improve operations. Are there cash inflows or outflows that can be changed?

Cash inflows can be increased by adding new outside cash (usually a limited or one-time option) or, more commonly, by offering a discount for cash payments or for accelerated payments on regular accounts receivable (so-called "quick pays"). Another option for businesses normally offering open account credit (which become the Accounts Receivable), is to offer credit cards instead. Today, even many corporate customers, including many agencies of the federal government, utilize credit cards for purchases to eliminate much internal paper work for themselves.

Cash outflows can often be reduced and/or delayed. They can be reduced by eliminating certain costs (Do you really need a …?) They can frequently be delayed by negotiating or taking longer payment times than you have observed in the past. Many smaller businesses pay their monthly bills (their Accounts Payable) more quickly than they need to in an effort to maintain a good credit rating. The primary criterion here, however, is not necessarily how quickly you pay, but the consistency with which you pay. If you are inclined to pay bills at the end of the month in which they were received, instead, establish a policy to pay 30 or 40 days after receipt. You will automatically gain the equivalent of one to three weeks spending as a one-time improvement in your cash balances, and may be better able to align outflows (expenditures) with inflows (receipts).

If you are coming from a finance background, this is definitely nothing new to you but if you are not, then here are some simple steps that you can take in order to start managing your Cash Flow with your business plan:

1. Set a period of 24 months as your scope of planning. If you can not breakeven within 24 months, I would recommend you to really reconsider whether you want to proceed with the business idea.
   
   
2. Forecast your monthly regular expenses with enough headroom for all unforeseeable items. You may just include an item called “Miscellaneous” if you do not have a clue for the time being.
   
   
3. Forecast your monthly sales with a progressive growth rate. You need to be extremely conservative in order to ensure you are not over promising yourself the sales revenue before you have real data to support these forecasts. You can always revise it up and evaluate when the plan seems to be working or after running the business for a period of time. One thing to note is that even you have sales orders in each month; you may only receive payment after 30 days (or more) depending on credit terms you give to your customers. Accounts Payables always tests a company’s finances.
   
   
4. Forecast your monthly sales cost in relation to the forecast sales. You have to bear in mind that sometimes higher sales volume means you have to increase labor; so labor costs or salaries have to rise proportionately.
   
   
5. Calculate monthly profit (or loss) by totaling up sales and subtract expenses and sales costs. You will instantly see on which month you start making profits. The initial months will mostly be negative figures (i.e. losses) until total sales are higher than the sum of expenses and sales costs (including cost of goods).

After doing the above steps, you now can probably answer the most important question before you start any new business. That is, how much cash or capital should you invest in order keeping your business running until profit starts to build up? It is a relatively simple calculation as you just need to add all your losses in the initial months together plus two to three months of regular expenses (and sales costs) to make up the total capital required for your new business investment.

For example, you estimate it will take eight months before you can make a profit from your new business and the total loss is Rs. 700,000 during this period. You also calculate your monthly expenses and sales costs to total Rs. 100,000. Then your minimum cash required to invest at the beginning should be no less than Rs. 700,000 + (Rs. 100,000 x 3) or Rs. 1,000,000.

It may sound very simple but as others will tell you, business is very dynamic and no two companies will experience exactly the same conditions. What is certain though is that dynamics of the market are the same and so be prepared for uncertainties. Still, it is extremely useful to do such exercise in order to have a quick reality check of your business idea. This is the very reason why I did not start up my business early in the process as I could not shorten the loss period to minimize my investment risk!

Understand what your own cash flow cycle is. This process will take time and thought - otherwise it won't work. It is essential to take time to experiment with combinations of different alternatives. A controlled cash flow, the end result of this process, will more than repay the time and effort given to it. In fact, it may save the life of the business - and the future of the owner/managers as well.

Run your business - don't let it run you. This is COMMON SENSE.

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