So you have a great product and it’s selling like gangbusters! Depending on the way you’re tracking and managing your income and expenses, you may still not have the cash you need to stay afloat. Can you make the next lease payment and payroll? Do you have the cash to inventory sufficient to meet demand? Can you invest in needed product enhancements and customer service to ensure continued market acceptance? Have you taken all of the proper steps to ensure that you’re minimizing tax liability and meeting all relevant tax requirements?
Cash Flow Management
Cash is the life-blood of small business, and controlling cash flow on a daily basis is the paramount job of the business owner. You should always know how much cash you have on hand, how much is coming in, and how much is going out. The day-to-day work of Cash Flow management involves:
- Minimizing the time it takes to receive and process payments from your customers.
- Controlling timing, amount, and payment terms for your expenditures to maximize cash on hand.
- Managing working capital and maximizing proceeds from any other credit sources.
Cash vs. Accrual Accounting
There are two ways to set up your bookkeeping for the business. Cash Basis accounting recognizes income as cash only when it is actually received from a customer, and recognizes an expense only when it is incurred. It is a simpler method of accounting and preferred by many business owners. The downside is that it may not give you as accurate a picture of your total operational profitability as possible, because it doesn’t recognize sales contracts that you have completed but not charged for yet.
Accrual Basis accounting recognizes income when you make the sale, which could be long before you actually deliver and charge for the goods or services you’re providing. Likewise, it recognizes expenses when you make the purchase, which could be before you actually pay for them. This can get pretty complicated if you have customers who prepay for items that you don’t yet have in stock, or suppliers to whom you return unused inventory after a specified time period.
Internal Revenue Service rules generally require businesses with inventories to use Accrual Basis accounting unless they have sales below $1 million per year. If you don’t fall into that grouping, you can still elect the accrual basis if you believe it will give you greater control over your management of the company.
Projecting Cash Flows
Even with strong sales, businesses often run short on cash. There is often a lag between income and outflow. Imagine if key customers pay you in 45 or 60 days while you have only 30 days to pay your suppliers and must also meet a weekly payroll and monthly rent. Being able to accurately predict when you’ll have more bills than you have cash is critical if you are to keep your business healthy. If you can see a problem shaping up while you still have time to correct it, you have a more viable business.
Creating a cash flow projection is similar to generating a Profit & Loss statement (See Section 22. Profit, Loss & Equity), but looks closely at cash-on-hand over time and also incorporates additional sources of income, such as capital loans from the owners of the firm. You can set up one in Excel or download a free cash flow projection template from SCORE here. To determine cash on hand at the end of a (usually a month), simply:
- Mark down: Cash on hand at the beginning of the period
- Add: Cash receipts for the period
- Subtract: Cash payments for the period
The net of this formula will be your Cash on Hand at the end of the period.
Run This Analysis into the Future. Doing this analysis for the actual period you’re in is a good start. But the cash analysis is most powerful when used to project over several time periods. If you look at the beginning of each month for the next six to 12 months, for example, you’ll know where the trouble spots lie and can take advance action to avert them.
Expanding Available Cash
Knowing when you most need cash to be available, you can now take various steps to mitigate any shortfalls:
- Analyze your accounts receivable. Identify which incoming payments will be used to offset which expenses. Increase efforts to collect on overdue invoices and consider tightening your payment terms for future contracts or for customers who regularly are delinquent in their payments. Consider asking customers to have their banks pre-authorize checks so your bank can draw against them more quickly when they’re deposited. You might offer customers discounts for early payments. Could you tighten credit terms across the board? Look for larger patterns, such as seasonal payment cycles, that you can be prepared for in advance.
- Study your accounts payables. As with accounts receivable, identify obligations that you must prioritize and at what point you will be able to make payments. If necessary, contact your creditors to request an adjustment of due date. Look for larger patterns that you can plan for to ward off crises, including unnecessary spending that could be pared or ways to adjust the timing of certain purchases to alleviate a future cash crunch.
- Secure or expand credit availability. Every business should have available a line of credit with their bank, to draw on in times of need. (See Section 21: Banking & Finance).
- Bail out time. In a real pinch, consider injecting capital in the form of a loan from the owner.