o Cash ? In this context, what is meant by cash is the actual amount of money available in the bank or in the business. It does not include inventory, neither does it include receivables or fixed assets such as property. Though these can be potentially converted to money, they are not liquid, and hence cannot be termed ready cash. In other words, cash is what you can use immediately to pay the bills and keep your business running.

o Cash flow ? This refers to the movement of cash in and out of a business. Cash coming in is what you receive from customers, lenders and investors. Cash going out refers to the payments you make every month for salaries, supplies and interest to creditors. If the cash inflow exceeds the outflow, a company has a positive cash flow. A positive cash flow is a sign of good financial health. In the opposite situation, a company is said to have a negative cash flow, a problem to say the least!

How do you beat this? To begin with, develop a cash flow projection. This should be a two-fold project – short-term (with a weekly or monthly periodicity) cash flow projections to help manage daily cash needs, and long-term (ranging from one to five years) cash flow projections to finance your larger business requirements.

For small businesses, the need for cash flow management is mainly to avoid extended cash shortages, a common occurrence when expenses for purchase of materials, payment of license or permit fees and wages may have to be made before the business gets paid by its customers.

How can you close this cash flow gap and keep your business solvent? Shorten your cash flow conversion period by following 5 easy steps that can help bring in the money faster:

1. Collect payments promptly ? Send out your invoices the same day goods are shipped, not a week or two later. Indicate on your invoice when payment is due, and specify the penalty interest for late payment.

2. Track accounts that are overdue ? Actively pursue unpaid accounts. Call the companies and send reminders letting them know that their account is past due and the steps that will follow should they not pay.

3. Cut expenses as much as possible ? Take a hard look at the expenses column on your cash flow chart. Are all the expenses listed in that column really necessary? Are there things you can do without? Is there anything you can find a cheaper deal on? Answers to these questions will probably end up saving you quite a few dollars.

4. Account for people not paying on time ? Remember, people don?t always pay on time. In fact, they need to be reminded more than once that payment is due. When making your cash flow projection, account for the fact that it usually takes people longer to pay you than you think. In case you?re offering a long credit period, communicate with the company at least four weeks before the invoice is due to make sure it gets paid on time. You might even offer your customers a discount for paying their invoices early.

5. Project a ?worst-case scenario? ? Always overestimate your expenses and underestimate your income. This will allow you to plan and be prepared for cash shortages.

To keep your business up and running, you have to have money coming in regularly. Track your cash flow closely so that you can predict potential problems and take steps to remedy them.

Ideally, you should have more cash flowing into your business each month than flows out. In reality, things are usually more complicated. An expected payment is delayed, several large bills arrive early, and your thriving business is suddenly in trouble.

Prevention is always better than a cure, and one way of spotting potential problems is to use a detailed cash flow forecast. When the forecast figures are significantly different from the actual sums received or paid they will highlight areas of your business that need adjustment. A qualified bookkeeper can help you draw up a forecast and alert you to pitfalls you might not have noticed.

But even the best run business can encounter cash flow problems through no fault of its own, so it also makes sense to ask some ?What if ??? questions and know what to do in case of difficulty.

What if customers can?t or won?t pay?

This is probably the most common cash flow problem. Although you want to attract and retain plenty of customers, don?t let the promise of large or regular orders blind you to normal safeguards. If you offer credit terms, ask for and check credit references for new customers. Make sure your terms are clearly stated and stick to them. If you allow 30 days for payment and the invoice has not been paid by Day 31 you need to chase it.

If polite requests go unheeded, many businesses find a formal letter will do the trick. Don?t forget to point out that you are entitled to charge interest on overdue debts. If large amounts are involved you might have to consider taking legal action or calling in a Debt Collection Service.

Persistent late-payers sometimes cost more in time and effort than their custom is worth. Ask yourself if you really do need to trade with them.

What if other people have cashflow problems?

Economic downturns are bad news for everyone. When a big company fails or needs to make drastic cuts, it can affect dozens of smaller businesses along the supply chain. If a normally good customer tells you he can?t pay because he, too, is owed money try to find a new, mutually acceptable arrangement such as allowing him to pay in instalments. As well as helping to keep both of you in business, your understanding could be rewarded with his loyalty when circumstances improve.

Before we more on to the analysis of our cash flow challenge, let’s take our small business story one step further and see what happens when we land a really big order.

The Big Order Problem

As you remember, our small business is used to doing $10,000 in sales every month. We’ve learned to manage that and have adequate cash supplies and financing in place to do business.

Suppose now that our business gets an order for $100,000, ten times our usual monthly amount. This is a great problem to have, but it can also be very dangerous for a company if they don’t manage it right.

The first challenge is that we probably need to negotiate some extra time to fulfill the contract. Let’ say the customer agrees, three months to deliver instead of the usual one.

Now we need to line up additional staff and larger contracts with our vendors. Chances are that since our vendors are not used to such large orders from us they are going to want some sort of down payment to insure the order. That’s a little more money we need to find up front; more financing.

At the end of the day ten times the orders means ten times the financing. Our small business is suddenly faced with financing $60,000 this month instead of the usual $6,000, and the term is going to be 90 to 120 days instead of 30. That’s going to raise some eyebrows at the bank for sure. Do we have the credit rating to warrant that amount? We may well be able to get it, but not without bringing more information to the banker. They will want to see a business plan with things like a copy of the order, insurance, and a background credit check on our big new customer. All things that can be provided, but the situation needs to be managed.

And finally, what happens if we something goes wrong and we fall behind in production? In our small business example we may no longer be in a position to bail out our company using our personal finances. In a big company the same think can happen. If our project goes wrong, and either the bank or our customer looses faith in our ability to complete the order we could be in a position of having to lay off staff or shut down the business altogether. More than one big company with a healthy balance sheet has declared bankruptcy as a result of poor variable cost, cash flow management.

Summary

Getting a big order is not a disaster, in fact it?s cause for celebration. But an unusually large order does require close management to become a success. Before you leap in take some time to work out the likely cash flow scenario to make sure your business can handle it. Big orders are great if they are managed right, just be prepared to with your financing options and business plan.

In part 3 we analyze our cash flow scenario and lay out some practical management tips for managing business cash flow.

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Topics include: * fundamentals of cashflow analysis * developing and implementing control mechanisms * case studies in cashflow management * exercises for enhancing cashflow control… More >>

Cash Flow Control

The biggest challenge in controlling variable costs is that you often need to make the decision to spend before the actual sale is made, and you often need to pay your bills before you can collect payment. To top it all off, if you guess wrong on your planned income you still need to pay your vendors and your staff.

The Cash Flow Problem

Let’s look at the typical flow of cash inside a small business. A similar situation applies to most businesses, regardless of the size. The only real difference is the amount of money and the number of people affected. For the sake of illustration we will track a small business that plans to do $10,000 in sales this month at a 40% profit margin. The plan looks like this.

Planned Sales: $10,000

Materials: - $3000

Assembly Labor: - $3000

Profit Margin: $4000

Let’s watch what happens to our balance sheet and to our cash as we progress through the month.

Day 1

The first thing we need to do before we can start producing anything is to purchase some labor and materials for our business. In an ideal business scenario you could sell the products first, and then find all the materials and staff, but in the real world you need some assurance of available labor and raw materials before booking an order. So you predict your sales as best you can, and go hire the required number of factory workers. Then you put an order in for the minimum amount of materials you think you will need. You just made a hard financial commitment, and maybe even had to make a small down payment up front.

To keep our example simple we’ll assume our small business is really good and managed to negotiate 30 day payment terms with no down payment from our vendors. Let’s say we also booked an order for the entire month’s sales projection on day 1. Next we ran out and lined up staff and raw materials the next day. You have to agree a business scenario can’t get much better than that. This would be a pretty good situation to be in. Let’s see how the money flows in a positive situation like this.

Balance Sheet Money

Day 1 Order Taken for $10000, Balance = $10000

Day 2 Get materials from vendors (-$3000), Balance = $7000

Day 2 Sign assembly staff contract (-$3000), Balance = $4000

Real Cash

Day 1 Order Taken for $10000, Balance = $0 (not collected yet)

Day 2 Get materials from vendors (-$3000), Balance = $0 (not paid yet)

Day 2 Sign assembly staff contract (-$3000), Balance = $0

Our financial sheet shows that we are right on track to make our $4000 this month, and although we have agreements in place, no hard cash has changed hands yet.

While we are looking at this let’s consider what happens if we don’t have all the orders for the month yet but we have completed everything that has been ordered so far? This is a very practical management decision point. You can stop using materials, but your staff is going to keep coming to work. Do you pay them to do nothing, do you send them home, or do you take your best guess at what you are going sell and get them started building things you hope you will need?

If you put your assembly staff to work you won’t have them sitting idle, but they will start using up materials. If you guessed wrong on what they should build, you will have to buy more materials to build what actually gets ordered, and either store or scrap what they’ve already made. Either way, your materials costs go up if you guess wrong. If you guess right, you save the company a lot of money. The right answer depends entirely on the business you are in, your confidence level, and the cost mix of labor, materials and storage space.

Day 15

So let’s go back to our small business example and assume we completed building the order on day 15, and pay the assembly staff for the 2 weeks work. Since we have 30 days to pay our materials vendors, we keep that money for now.

Balance Sheet Money

Day 1 Order Taken for $10000, Balance = $10000

Day 2 Get materials from vendors (-$3000), Balance = $7000

Day 2 Sign assembly staff contract (-$3000), Balance = $4000

Day 15 Product Delivered, Balance = $4000 (already accounted for)

Day 15 Pay staff the $3000 we owe them, Balance = $4000 (already accounted for)

Real Cash

Day 1 Order Taken for $10000, Balance = $0

Day 2 Get materials from vendors (-$3000), Balance = $0

Day 2 Sign assembly staff contract (-$3000), Balance = $0

Day 15 Product Delivered, Balance = $0 (not collected yet)

Day 15 Pay staff the $3000 we owe them, Balance = -$3000

Our balance sheet is looking good: $10,000 ordered, paid out $3000, promised to pay $3000 more later.

But look what’s going on with our real cash. We had to write checks for $3000, but we haven’t collected any money yet. In fact, if our customer agreed to pay us 30 days from delivery like we did with our vendors, we are not going to see that cash for another month!

If this is a real business, we need to finance that $3000 somehow and make good on our promise to pay $3000 today. We won’t get into the financing options here, but it basically comes either from a company bank account, the owner’s personal account, or from a lender in the form of a short term loan.

Day 30

Let’s skip ahead another 15 days; it will still be two more weeks until we get paid by our customer. It’s also the day our materials vendor needs to be paid for the materials we bought on day 2. Let’s take another look at the cash flow analysis.

Balance Sheet Money

Day 1 Order Taken for $10000, Balance = $10000

Day 2 Get materials from vendors (-$3000), Balance = $7000

Day 2 Sign assembly staff contract (-$3000), Balance = $4000

Day 15 Product Delivered, Balance = $4000

Day 15 Pay staff the $3000 we owe them, Balance = $4000

Day 30 Pay vendors the $3000 we owe them, Balance = $4000 (already accounted for)

Real Cash

Day 1 Order Taken for $10000, Balance = $0

Day 2 Get materials from vendors (-$3000), Balance = $0

Day 2 Sign assembly staff contract (-$3000), Balance = $0

Day 15 Product Delivered, Balance = $0

Day 15 Pay staff the $3000 we owe them, Balance = -$3000

Day 30 Pay vendors the $3000 we owe them, Balance = -$6000

Nothing much has changed on our balance sheet. We had already written off the money we knew we’d need to pay, and are still showing a $4000 profit. But again we find ourselves having to pay our bills before we collect any money.

If you are a small business like the one in our example making $4000 a month profit, $6000 is a lot of money to be financing every month.

Day 45

Today is finally the day we get paid. Assuming our customer pays on time we will finally be able to get our cash flow out of the red.

Balance Sheet Money

Day 1 Order Taken for $10000, Balance = $10000

Day 2 Get materials from vendors (-$3000), Balance = $7000

Day 2 Sign assembly staff contract (-$3000), Balance = $4000

Day 15 Product Delivered, Balance = $4000

Day 15 Pay staff the $3000 we owe them, Balance = $4000

Day 30 Pay vendors the $3000 we owe them, Balance = $4000

Day 45 Collect payment owed to us for $10,000, Balance = $4000

Real Cash

Day 1 Order Taken for $10000, Balance = $0

Day 2 Get materials from vendors (-$3000), Balance = $0

Day 2 Sign assembly staff contract (-$3000), Balance = $0

Day 15 Product Delivered, Balance = $0

Day 15 Pay staff the $3000 we owe them, Balance = -$3000

Day 30 Pay vendors the $3000 we owe them, Balance = -$6000

Day 45 Collect payment owed to us for $10,000, Balance = $4000

Finally our cash flow catches up to our balance sheet, and we are showing a positive picture on both sides of the equation.

Summary

Cash flow management is very practical business, and is well understood by all strong business leaders. To succeed you must understand not only how much money you will make from a project, but how the money will flow along the way.

In parts 2 and 3 we will do a more detailed analysis of our cash flow picture, take a look at the “big order problem”, and lay out some very practical management tips for managing cash.

Below we paint the financial picture of our small business example from two different perspectives. Both tell the same story, but one is from a balance sheet perspective, and the other from a cash flow perspective. The only real difference is that the balance sheet includes money promised as well as real money. The cash flow picture only shows real money coming in or going out. They both end up in the same place, but paint two very different pictures of how we got there.

Balance Sheet Money

Day 1 Order Taken for $10000, Balance = $10000

Day 2 Get materials from vendors (-$3000), Balance = $7000

Day 2 Sign assembly staff contract (-$3000), Balance = $4000

Day 15 Product Delivered, Balance = $4000

Day 15 Pay staff the $3000 we owe them, Balance = $4000

Day 30 Pay vendors the $3000 we owe them, Balance = $4000

Day 45 Collect payment owed to us for $10,000, Balance = $4000

Real Cash

Day 1 Order Taken for $10000, Balance = $0

Day 2 Get materials from vendors (-$3000), Balance = $0

Day 2 Sign assembly staff contract (-$3000), Balance = $0

Day 15 Product Delivered, Balance = $0

Day 15 Pay staff the $3000 we owe them, Balance = -$3000

Day 30 Pay vendors the $3000 we owe them, Balance = -$6000

Day 45 Collect payment owed to us for $10,000, Balance = $4000

Understanding the difference between these two scenarios is a critical management skill. A company’s ability to survive quite literally depends on the smart management of cash flow.

Cash Flow Management Tips

So let’s look at the 4 big management tips to keep your cash flow situation running smoothly.

Delay payment to your vendors as long as you can. Ideally you don’t want to pay your vendors until after you collect from your customers. Very few businesses manager to arrange this, but the longer you can put off paying your vendors, the healthier your cash flow situation will be.

Collect payment as soon as possible. The sooner you get money from your customers the healthier your cash flow situation is. And when customers are late paying, make sure you are calling them to find out why.

Ensure you have adequate financing to handle the size and duration of orders you are taking. Factor the cost of financing into your financial equations.

Get the most accurate orders forecasts you can. This is critical to managing daily fluctuations in any production environment. Imagine what happens to our cash flow if we over produce and have to pay for things we don?t sell for a long time.

Summary

One of the biggest daily challenges of most businesses is cash flow. Most often variable costs make up the bulk of the money coming in and out of a business, and hence the bulk of the cash flow problem. You must learn not only the numbers, but also the timing. In the world of variable cost, cash flow cost control, timing is everything. Learning to manage time and money well together is one of the most practical management skills you can ever learn.