Many small business owners attempt to simplify cash management to a "checkbook - cash flow" approach or a "profit-and-loss approach." Both ways can be misleading when simply considered individually.
Cash flow from operations is usually the easiest to identify. In a simplistic description it can be stated as cash received from business operations minus payments made to obtain the pending receipts. It is all too often that a major component of the expenses relating to operations namely inventory is overlooked or improperly valued. This is true whether you are dealing with a retail operation or a construction company.
Obviously you would desire to have the cash flow from operations to be positive, showing that the company is growing. However, since inventory is classified as an asset on the balance sheet, it is not taken into account that it is not a liquid asset that is instantly convertible into cash. Although accounts receivable are also classified as an asset from a profit-and-loss approach, it is clear that different payment terms for your customers will determine when the receivable will become liquid from a cash flow approach.
At times it would appear prudent to purchase spare inventory due to reduced prices or forecasted product shortages or price increases. However, this investment in inventory could deplete your cash availability for some time, and your accounting procedure may not identify this potential cash-flow problem. Also, your balance sheet and profit-and-loss statement will value the inventory and not red flag the situation. This is especially dangerous when your investment in inventory is greater than the cycle time to generate cash from sales.
Other areas of concern are quarterly or monthly expenses such as payroll taxes or sales taxes that are not paid as the debt is incurred. It is critical that cash reserves are established for these payments so that there are no cash surprises during any fiscal period.
Financing is a method of compensating for any cash deficiency from operations. This does not necessarily mean that your company is in trouble because of a need for financing. After all, there are extremes in the business world. A restaurant has a short production time and no extended terms on their accounts receivables. A small retailer might be relying heavily on credit card sales and therefore will be paid according to the terms with the credit card company which could delay the actual cash deposit to the company's bank account. A larger company may have created its own customer credit accounts and therefore are extending payment terms in exchange for enhanced income from interest payments. There are also extended payment terms required by the type of industry your company operates in. The two primary dangers in financing arise when the need comes as a surprise and when the true costs of the financing are not properly identified. As long as the financing makes business and fiscal sense and is an integral part of your business plan, it is normally a prudent way to operate.
Investing is the third area of cash control. Investing in your own company is normally considered to reflect a level of confidence in your company and a way to aid growth. This is not the only arena available to place your excess cash to aid in the growth of your company. It may be advisable to purchase commodity futures on your critical materials. For any type of investment, it is essential to complete an accurate calculation of the costs involved in the investment prior to committing the cash. This includes the time required to realize any return on the investment and an accurate calculation of the annual return on the investment.
Remember, investing is for the future, whether it be capital equipment, buildings or inventory. You are spending cash today to generate a growth in tomorrow's revenue.
The integral part of proper cash management is its inclusion in your business plan and careful review of the plan and its results on a regular schedule. With the dynamics of today's marketplace it is essential to pay attention to the reality of the market and be prepared to react positively. Your ability to react will always be determined by the cash position of your business so take care of those valuable dollars by controlling your operations, strategic planning and careful investing.
Steve Weich, a SCORE counselor with over 30 years experience in domestic and international business operations, is a former advisor to the country of Wales in corporate investments. He will conduct the finance session at the Business Survival Workshop at the UNR Extended Studies Center May 30.
