Synopsis
Making cash available to the business is the most critical concern for management because everything any business does over its existence depends on available and predictable cash flow. Every time a business loses control over its cash, it will quickly find itself in financial trouble. Learn nine key concepts to understand to reduce the odds of you experiencing cash flow problems.
When your business is running out of cash, the first thing to do is to stop all cash outflows. The number one rule of business survival is never to let cash outflows exceed cash inflows. The second thing you do is you project how much cash you see coming in this week. Knowing what your cash inflow will be drives how much cash outflow you can sustain each week.
Cash is the “lifeblood” of every business, no matter its size. Everything any business does over its existence depends on available and predictable cash flow. Making cash available to the business is the most critical concern for management. And every time a business loses control over its cash, it will quickly find itself in financial trouble.
What happens to a business that runs out of cash?
When you are out of cash, you are out of business. As soon as you owe people more money than you bring in, you have violated the number one law of business: when you are out of cash, you are out of business. Eventually, those you owe money to will run you out of business. First, by cutting off the products and services they provide you to run your business, followed closely by aggressive collection tactics that push you to close your business.
How do you improve your business cash flow?
To improve your business cash flow, you must fully appreciate the two most critical cash terms. The first is cash velocity—the speed of cash flowing in and out of any business. The second is cash quality—the degree of business excellence in sales, operations, and finance.
Why should I care about my business cash flow velocity?
Every day, businesses close because they run out of cash. Many of these business closures trace back to weak operating cash velocity. You can’t project your cash inflow if you can’t forecast when you expect to collect the monies owed to you. You start the process of gaining and maintaining control over your cash when your cash velocity reflects your customer payment terms.
How do I improve my business cash flow quality?
Every profit dollar earned is a reflection of the quality of your past management decisions. You improve the quality of your profits by improving your decision quality. The fastest way to improve your decision quality is through the development of a profit plan. A profit plan is more than projecting numbers you would like to see on your P&L Statement. It is the set of actions you commit to taking to achieve a targeted profit level. These actions involve the development of an interlocking set of short-term budgets that roll up into a master plan for profits and cash reserves.
What is the number one problem associated with business cash flow?
Most people think that the number one problem with business cash flow is collecting the money owed to you; this is the number two issue. The number one issue with the velocity of your cash collection is cash quality. If all your business does is bring in dollars to pay your employees, suppliers, and everyone else but not you, then you have a problem. When you only leave yourself pennies on every dollar you pay out to everyone else, you will quickly owe more than you collect. When this happens, you now have a cash velocity problem.
Consider the results of the following three businesses by looking at their cost structure through a dollar, then pick the one you would like to own:
Business A |
Business B |
Business C |
|
Sales of … |
$1.00 |
$1.00 |
$1.00 |
Direct Labor |
.20 |
.10 |
.35 |
Materials |
.25 |
.20 |
.15 |
Equipment |
.05 |
.10 |
.15 |
Gross Profit |
.50 |
.60 |
.35 |
Marketing |
.10 |
.10 |
.05 |
Office Payroll |
.20 |
.15 |
.12 |
Outside Fees |
.04 |
.07 |
.10 |
Insurance |
.01 |
.03 |
.02 |
Rent |
.08 |
.10 |
.05 |
Utilities |
.03 |
.03 |
.02 |
Operating Profit |
.04 |
.12 |
-.01 |
It doesn’t take a complex financial analysis to determine which of the above three businesses would be best to own. You only need to follow what happens to a dollar by converting all expenses flowing through the business into a percent of Net Sales and then apply that same percentage to a dollar.
From the business comparison above, you likely picked Business B because it’s generating twelve cents of operating profit on every dollar, not losing one cent like Business C. This is “cash quality.” Business B has better cash quality than Business A, whereas Business C has negative cash quality.
What causes business cash flow issues?
Cash velocity issues occur every time a business fails to stay on top of its accounts receivable. Most of the time, it is because they don’t like asking people for money, even when it’s money owed to them. Too many business owners find collection calls distasteful, so they don’t make them, even when cash inflow is needed.
Interestingly, those who dislike calling about invoices due to them are the same ones dodging calls from their suppliers who aren’t hesitating about getting paid. These owners are not connecting the dots. They need to appreciate that anytime they’re making calls, asking to be paid, they need to address the calls asking them to pay. It’s the only fair way to do business.
Nothing good happens in your business until you get paid.
Cash quality only matters if you are collecting the cash owed to you. You can’t start managing your business for profit if you don’t stay on top of collecting the money owed to you. The velocity of cash flowing through your business is the most urgent business need when your customers are late paying you, but not the most important.
While Your accrual-based P&L Statement will record every sale you made, this is of no value to you until your bank statement reflects the cash received from the payment for that sale. Step 1 of BusinessCPR™ starts with collecting the monies owed to you in a timely fashion, and step 2 is the bridge between improving cash velocity from Step 1 and confirming cash quality in Step 3.
How do I overcome a business cash flow problem?
No matter how profitable a business is, if the money that should be in the business is sitting in its customers’ bank accounts and not in their bank account, it is a business in trouble. Smart business owners overcome cash velocity issues by using great discipline to manage their accounts receivable (A/R) collections. Failure to collect monies owed to you is the leading cause of businesses unnecessarily burning through their cash reserves.
Do you want help to improve your cash availability?
You are not alone. Click here for a “free” cash velocity risk assessment profile from a certified BusinessCPR™ Business Scientist with tips on accelerating your cash velocity.
Do you have a cash velocity problem?
Click the link below for a “free” cash velocity risk assessment profile from a certified BusinessCPR™ Business Scientist with tips on accelerating your cash velocity.
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