10 Cash Flow Rules To Follow
Apr 22, 2008
Cash flow problems kill businesses! According to a recent bank survey, approximately 80% of business failures were due to cash management issues. To avoid becoming another number in this statistic, here are 10 cash flow rules to follow:
1. Net income does not equal cash flow. You cannot determine your cash flow and run your business using the income statement alone. Customers do not pay COD, your investment in inventory maybe going up, you have loan payments and purchase equipment, and there is other accounting jargon going on, i.e., write-offs, adjustments to inventory, depreciation, etc., You will need to use the statement of cash flow to determine your cash flow. More on that later.
2. Do not manage cash from your gut. Do not try to do it on the back of an envelope or in your head. Worse yet, do not manage the business based on how much cash is in the bank this morning; this is not an indication of the future. Today's revenues do not equal cash and today's expenditures do not mean you have to pay the bill.
3. Growth consumes cash. Have you ever heard the following or something like it? "We had a record sales month and we have never had so many employees, but we can not meet payroll." Every business wants to grow. However, one must be careful because growth consumes cash. It is a matter of working capital (accounts receivable, inventory and accounts payable). The faster you grow, the more cash and/or financing you need.
4. Inventory consumes cash. You have to purchase or build product before you can sell it. Even if you do not sell it, your vendors will want to be paid. Remember that every dollar in inventory is a dollar you will not have in cash.
5. Manage working capital. Working capital is accounting terminology that subtracts current assets from current liabilities. It is the change in accounts receivable, inventory, accounts payable, short-term debt and lines of credit in a short period of time. Never let working capital get negative. Monitor receivables, inventory and accounts payable weekly. If not, you will lose control.
6. Do not surprise the bank. Do not hide from your bankers. If growth is in your future or you know you will have a short-term cash crunch, prepare a good plan with supporting projections and show it to the bank. The sooner the better. This is not the time to show off "pie in the sky" numbers either. Be realistic.
7. Key operating indicators. Every business has a handful of key operating indicators unique to that business. However, these must be monitored regularly as they have a high impact on cash.
- DSO - days sales are outstanding - measures how good the collection team is
- Inventory Turnover -the number of timesyour inventory turns in a year
- Payment Turn - how long it takes you in days to pay your vendors
- Sales - check your actual sales to your forecast...by salesman and customer, if possible
- Payroll - monitor dollars and head count (if you don't, you "will" be over budget!)
8. Statement of cash flows. This financial statement is rarely used and understood by many business owners and CEOs. Unfortunately, it is the best financial statement of the bunch. It deciphers net income (not cash) and changes in balance sheet (accounts receivable, inventory, accounts payable, loans) to tell you where your cash came from, where it went and how much is left. Study it! Understand it! If your accounting department can not generate one, find someone who can.
9. Projections. If you are downsizing due to the economy or experiencing growth, it is imperative you have a twelve-monthly rolling projection. This is not limited to the income statement alone. You will need to do this for the balance sheet and statement of cash flow as well. Here, key cash consuming items like inventory, receivables and debt will need to be projected. These items are often the hidden cash consuming factors that are overlooked creating cash flow problems.
10. Weekly cash flow. If cash is tight then you will need to prepare a detailed 13-week cash flow projection. This will include cash collections estimated from your receivables department as well as a detail list of vendor payments. Stick to it. Do not spend more then you collect. If necessary, arrange payment plans with vendors to get through the crisis. You'll be surprised that vendors will work with you when you open communications.
