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Effective Cash Management Techniques for Small Business

For any successful business – managing cash is NOT an optional “to do.” In particular, because small businesses (often) lack sufficient resources or access to capital, cash management plans are essential for small businesses to prosper (and, in many cases) survive. If a business does not forecast or plan ahead to address periods where they expect to have a cash shortfall (in periods of slow growth, seasonal trends or unexpected costs) it runs the risk of being unable to pay it’s employees, service it’s debt obligations or pay it’s vendors. Each of these situations could force the business to sell some (or all of it’s assets), downsize to conserve cash or discontinue/disband its operation to (liquidate) and settle it’s obligations.

EAS is about helping the small business owner with practical tools. So let me address a topic no business wants to discuss or acknowledge-Failure. Businesses fail for a variety of reasons, but at or near the top of the list of root causes – they do not budget for or manage their cash. It’s often a lack of discipline that causes a liquidity crisis and the ensuing stress that makes many Owners, Partners or Shareholders, throw their hands up, exclaim “screw this” (or something more colorful) and give up on their dream and their business, and hunt for a job.

Effective Plans – Keep it Simple

I’m not advocating that business owners spend hours and hours creating extensive, intricate Excel Spreadsheets or PowerPoint Slides. A waste of time. But, outside the normal course of operating activities, businesses (too) need to understand their unique risks. Lacking even a rudimentary plan to estimate the amount (and types) of resources your business needs to both operate and address future challenges places your business at further risk.

Some people may disagree with me on the importance of planning. This post is targeted to those owners that appreciate and value planning. Planning forces you to understand your business, much better. Over time, as you accumulate data you will understand the “dips” and “swings” in your operation (fluctuations that are more pronounced if you have seasonal changes) and you’ll be able to anticipate and put in place, tactics to minimize or eliminate issues before they become worse. The best managed companies ALWAYS plan and some do very well even in an economic downturn. But planning requires time and thought for it to be accurate and therefore, relevant and reliable.

Start with Good Data

Two quick statements. The Accounting Platform, itself (like QuickBooks) is nothing more than a tool to help you develop a good plan. But problems occur when the transactions, the source data and the records, that are input, are themselves incorrect, misstated, or worse, intentionally misleading that create all sorts of havoc, and owners relying on such data can make lousy decisions. A solid plan starts with good data-no mystery.

One other comment – you need to separate your personal life and situation from your business. Commingling transactions, or using your business accounts as “piggy banks,” will lead to problems. If you create plans without this in mind (you commingle) whatever plan(s) you develop will have little or no accuracy or relevance toward your business.

Business owners, more often than not regard Accounting or Bookkeeping as a necessary obstacle-something they must comply with to avoid trouble. But, in the course of running their business, they (usually) amass this huge reservoir of data with little or no thought on how to use it to manage their operating activities more effectively.

In this age of disruptive technology, small business owners have a plethora of Accounting Platform options to choose from, some web based with (relatively low) monthly fees. These platforms allow owners to capture transactions and records and over time, (given the accuracy of the data) the ability to understand these trends to use in decision-making. Businesses, especially those that are seasonal would find it beneficial to understand how these seasonal changes impact their operation, to better anticipate problems and create plans to address them.

Importance of Cash Management Explained – A Framework With Techniques

In this short post, I wanted to put together something that I thought would be helpful or insightful for the small business owner to address cash needs and lay a foundation to develop a simple cash management plan-using a common financial ratio called a Current Ratio.

Current Ratio = Current Assets / Current Liabilities

If your eyes are glazing over, or you’re getting bored, please, stick with me.

Hate these mathematical models? Understood. But in practical terms, your business should have between 1.5 and 3.0 times more in current assets than current liabilities.

If you never created a budget, ok. But step back and think about all the items that you purchase every month – your utility bills, rent, salaries/wages, and any credit card or loan/debt payments.

A simple question – How do you ensure that your business generates enough cash to cover these expenses, every month, if you DON’T plan.

Covering Your Current Liabilities

Let’s start with current liabilities. Current liabilities are obligations that are due in the current operating period – a calendar year or fiscal year (if different than a calendar year). It also includes the portion of any long-term debt that is due in the current period. Liabilities need to be covered – these payments are not optional. Creditors can get nasty and force your business to pay, if you refuse. These liabilities, whether they’re credit cards, loans, mortgages, etc…put pressure on your cash for both interest and principal payments. Assuming that your Bookkeeping and records are up to date, you can run reports to understand when (and the amounts) that are due over your current operating period.

You need to have sufficient current assets (or a fancier term – liquidity) to pay down your current liabilities. Aside from your bank accounts, current assets consist of inventory or anything else that you plan to convert to cash in the current period. Again, current liabilities consist of trade accounts payable, credit cards, loans, mortgages, taxes payable, or interest due on any notes or debt in the current period. You may have obligations with more complex terms, but I’m simplifying this for brevity.

So, if you were to run a report for your current operating period and you find that your current obligations (due, by quarter) were:  $65K; $80K; $105K; and $90K, then this is the amount of liquidity you would need to pay these obligations down, in total, $340,000.

Cash Expenses

Now, consider cash expenses. Expenses are what you pay for, immediately, including salary and wages, rent, maintenance and office expenses. Non-cash expenses are (of course) excluded. Any realistic plan should also include a “cushion,” some additional percentage based on history to address those “situations” that always seem to arise.

Capital, Fixed Asset Purchases or Investments

Capital or investment cash outlays, that benefit more than one period of operation are (normally) put on your Balance Sheet and either amortized or depreciated over time – these outlays are not expenses, but they impact cash. If these purchases are financed over time, then these financed payments are included in your budget.

Estimate Your Cash Inflows

Now you need to estimate your cash inflows – the amount of cash you expect to collect from customers/clients and those assets that you expect to convert to cash in the current period. Looking at the history of your Accounts Receivable Aging would help to determine the timing of these inflows. Cash (to be received) can be estimated from sales revenue (the invoiced amounts) less any discounts or credits/refunds that were either offered or anticipated.

Another point. If you’re a merchandiser (for example) and you have outdated or obsolete inventory, you need to consider the value you would expect to receive if you tried to sell it. Be realistic. If you had to write the inventory down by 40 or even 50% to sell it, less any selling costs, then that’s what it’s worth. In all likelihood, it will not get more valuable over time, unless we’re talking about vintage Guitars.

Putting it Together

You should structure your plan by month, because most bills and expenses are recurring, by month. Your estimated cash inflows less your combined outflows (expenses, liabilities, any planned capital or fixed asset purchases, and others?) give you the amount of residual cash, on hand at month end or will highlight any cash deficit. How can you finance these deficits? The easiest way is through an accumulated cash position (from prior months) assuming you’ve accumulated enough cash to cover the deficit. If your accumulated position falls short, then what? A revolving line of credit is probably the best “safety valve,” in these situations. You take just what you need and replenish this account when the business is cash positive.

Final Thoughts and Wrap Up

Final thoughts. Net Income is a measure of Operating Effectiveness, not a measure of how much cash is generated. You can be rich on paper but cash poor. How? Liabilities/obligations/debt. This is what chews up your cash. Also, the act of paying down debt is NOT an expense, a common misconception. The interest on liabilities is expensed against the business’s earnings (on your Profit and Loss Statement), but principal payments are not.

This was just a simple (broad) overview, but I introduced some concepts and techniques to help you understand what would be required to prepare an effective cash management plan. In addition, I hope that my attempts to explain the importance of these types of plans was helpful.

Comments? Disagreements? Please leave in the Comment Section below this article or write to me at mike@easllc.co. You can also Contact Us Here.

Alternatively, you can Book a Call Here.

Here’s to a great and prosperous New Year!

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