Cash is King

Failure to understand your cash position and current and future cash needs can ruin a business, even a profitable one.The sad truth is that cash-flow surprises kill many startups. Overall, 90 percent of small-business failures are caused by poor-cash flow, according to Dunn & Bradstreet. To prevent becoming part of the 90 percent, you'll need to maintain a focus on cash. When it comes to the financial management of a growing company, always remember that cash is king. In this lesson, we outline some basic practices that can help you keep close tabs on your cash.

Managing cash is one of the most important functions you must perform. But cash flow management is not waiting until there is a problem and then panicking by paying just the smallest bills and let the rest slide or stretching out all payments until vendors complain; cash flow management is proactively taking actions that can improve your cash position. Here are a few suggestions to help you manage your cash position.

Managing Cash Flow

Good cash flow management means understanding every inflow and outflow of cash. In principle, you must delay every outlay of cash as long as possible, while incenting everyone who owes you money to pay it as rapidly as possible. Also, its about being vigilant about limiting any surprises such as unanticipated payment lags and unplanned-cash outlays. So how do you be proactive in managing cash? Here are some basic disciplines that every entrepreneur must understand and practice to optimize their cash:

  • Analyze Cash Every Week: Each week, check your cash balances and how your expected inflows and outflows of cash compare to your projection in your cash flow projection.
  • Check Accounts Receivable versus Accounts Payable: Your main inflow of cash is from customers for payments, called Accounts Receivable. Your main outflow is payments for services and vendors, called Accounts Payable. Your goal is to decrease the days it takes to collection your Accounts Receivable and to increase the days it takes to pay your Accounts Payable. Your accounting system should allow you to easily run these reports.
  • Monitor your Customer Balances: It is easy to fall short in the management of your Accounts Receivable (money owed to you from customers). Always use a software system to track who owes you money so that you can follow up with customers and send invoices and statements.
  • Factor or Sell Your Receivables: A last resort would be to factor or sell your accounts receivable to what is called a "factoring company" to maintain a predictable cash flow. These "factors" basically buy your accounts receivable, forward you a percentage (usually around 80 percent) and then have the right to the cash when it comes in. The balance, minus any fees, are then sent to you. The fees can be significant as high as 20 percent. Some companies include Fundbox and Blue Vine. Be careful with factors as many can be quite aggressive with your customers when payments are late. Make sure you set up the process for collections with them before you engage them.
  • Slow Down your Cash Disbursements: Prudent cash flow management dictates that you retain cash as long as possible. This doesn’t mean you become a deadbeat customer to your own vendors – you still have to pay on time, just not too early and not late. If your vendor offers any sort of early payment discount like a 2% 10, net 30 you will always want to take advantage of the cost savings. You can also try negotiating extended payment times with your vendors. The longer the cash stays in your bank account, the better.
  • Time Large Expenses: Get into the habit of setting aside small amounts to fund large expected expenditures such as business license renewals and quarterly estimated tax payments. It is best to put the money in a separate account that you don’t have regular or easy access to, that way you are not tempted to “raid’ it for splurge purchases.
  • Bill Up Front. Ask customers for payment on delivery, and only accept Automated Clearing House or credit card payments to avoid uncertainty or delay in payments. You can also enforce or encourage pre-payment. While some customers may be deterred by upfront payment, discounts can win them over, and late-payment charges can reduce overdue accounts and help you predict cash flow needs.
  • Send Invoices Far in Advance. Make sure you send your invoices far in advance. If you don’t give your customers enough notice, you’re practically asking for late payments. Also, track all outstanding invoices, and have a system in place for credit guidelines and follow-ups.
  • Understand What Each Dollar Gets You. For example, you might spend thousands of dollars getting booths at trade shows or hosting industry events and assume a certain return, but this estimation is unscientific and often inaccurate.
  • Practice Smart Inventory Management. Early-stage companies often overlook proper inventory management. While it’s important to ensure sufficient supply, startups tend to overstock or pick the cheapest transportation options, which can actually be more expensive once you take idle inventory costs into account. Another option to improve your inventory management while reducing your idle inventory is to speak to banks that offer inventory financing so you don’t have to tie up cash.

Managing cash is a full time job - but one well worth the effort.

Things to Watch that Impact Cash

Putting in place regular process to manage cash is key. But also keep your eyes out for the following which can hamper your cash efforts:

  • Being on Budget but Out of Cash. In the real world, spending seems to happen fast, and money coming in happens slowly. Thus your monthly budget may balance, but if planned inflows comes later than planned expenses, you have a short-term cash-flow surprise shortage - even if your sales are actually exceeding your expenses.
  • Being Profitable but Broke. Profits don't necessarily translate into cash. You can make profits without making any money, since the first priority of most startups is to reinvest everything back into the business for growth. There are lots of accounting tricks to make you profitable, but it takes real cash to pay the bills.
  • Seasonal Sales Fluctuations. Fluctuating sales means more inventory is required to cover the ups and downs. Every dollar in inventory is a dollar less in cash available or maybe even two dollars less if your gross margin is 50 percent. If you try to vary the number of employees to match, that costs even more cash for hiring, firing and layoffs. Try to set up your expenses to go up or down based on seasonality.
  • Unanticipated Expenses. Do your best to avoid them and plan for when they occur. Make sure you are building in some buffer into your cash plan for the unexpected.
  • New Businesses Don't Get Normal Terms. Established businesses get credit. Established businesses can dictate how their customers pay them. Not the case with new businesses. You may have to give away free trials. Plan for this in your cash forecast.
  • Sales Don't Always Keep Up with Marketing Expenses. In the early days of a new business, and every time you make changes, sales volumes slip just when you need them most to cover the extra marketing expenses and new infrastructure.
  • Late Payments—Even from Good Customers. The Kauffman Foundation reports that late payments are among the biggest challenges facing startups. According to the Receivables Exchange, small businesses now wait nearly 50 days on average to get paid.
  • Higher than Anticipated Growth Requires Cash. The faster you grow, the more cash you need to build products, facilities, staff and service. These are up front costs that can't wait the four or five months before the sales and revenue catch up. If you can't deliver to match the growth, your business will struggle.

Cash is king. Managing it requires proactively taking steps to watch your dollars. Use these tips and techniques to proactively manage your cash to give you the best chance for success.