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The Art of Cash Flow Management

As a business manager and consultant, the concept of poor cash flow is the greatest existential threat to a business. All too often, business owners look to their bottom line net income to benchmark the health of their business. Many of those same business owners are left wondering why they feel like they can’t get ahead; they’re worried about paying bills as they come due – or worse, wondering how they will fund the next payroll.


If any of this sounds familiar, you are not alone. According to the U.S. Bureau of Labor Statistics, one-third of businesses will fail within two years of inception, half of businesses will fail within five years, and two thirds will fail within ten years. Sure, some of these businesses will be affected by unforeseen circumstances like a catastrophic storm, a lawsuit, or an overnight change in consumer demands. But more often there are small day-to-day deviations from business principles and values that ultimately alter the trajectory and health of a business. As a business owner, these decisions are often completely within your control, and it’s important to recognize what they are and how to identify the impact they make on your business.


SEASONALITY

One influence on a business’ cash flows can be seasonality. Take, for instance, the obvious example: an ice cream parlor on the shores of Ocean City, Maryland. A summer destination to be sure, it’s clear this business earns almost all its revenue in the summer months. This cash must last the business through the down fall, winter, and spring months until it’s time to pull out the beach gear again.


In this scenario, it’s vital that this business owner understand the fixed costs required to run the business year-round and to be cognizant of the variable costs (i.e. labor, goods) to ensure that the money generated from the business can suitably last for the entirety of the year. Any errors within the calculation will undoubtedly require capital infusions and, should that not be feasible, could risk the business’ existence altogether.


Not unlike the extreme ice cream parlor in a summer destination town example, many small businesses carry seasonality trends and may not realize it. If your business runs all-systems-go all year round and revenue decreases are not accounted for, you risk running into a cash crunch and being unable to pay your bills.


Fortunately, there are ways of hedging against seasonality. First, developing a monthly operating budget at the start of the year allows the business to benchmark itself and project variances throughout the year. This is a vital component to any business regardless of size or industry. Second, creating and funding a cash reserve during peak seasons can protect a business during weaker seasons and allow the business owner to meet its obligations as they come due. Third, establishing business credit can provide some additional liquidity to a business, though careful attention and responsible use must be emphasized, and its utilization should be built into the budget or projection. Last, and if feasible, a fourth hedge can be to identify alternative revenue streams to supplement income in down months.


TERMS

Another influence on business cash flows is payment terms, both for vendor payables and customer receivables. While terms can vary based on credit worthiness and other factors, general vendor payment terms are 15 or 30 days from invoice. Consequently, business owners also have discretion on the terms they provide to their customers.


Say, for instance, a business owner allows its largest client 45 days to pay its invoice, but the vendor costs to produce that service require 15-day terms on the business owner to pony up, in addition to the payroll and other costs required to provide the service. This, in effect, creates a temporary cash flow issue insofar as the business owner has outlaid the cost of service and has not received the customer cash for that service. Should the customer fail to pay within 45 days, this can subject the business to a cash flow nightmare, particularly without proper planning and guidance.


There are ways to mitigate this as well. First, creating an effective cash management program can allow you to track spending and available cash and to project out short- and long-term cash requirements. Second, a diligent review of vendor and creditor terms can allow a small business to close the gap between cash receipts and cash disbursements. As mentioned, creating and funding a cash reserve can also serve to provide peace of mind, knowing that good faith extensions of customer credit won’t impact the ongoing operations of a business. In certain cases, utilizing credit can further extend the terms of cash disbursements, though I caution again that careful attention and responsible use must be emphasized, and it should be appropriately budgeted for.


In the end, the best way to manage cash flow is to find a trustworthy consultant who can help to identify risks and work to develop a comprehensive plan to address them. While no two businesses are alike, a strong consultant can make recommendations based on direct concerns and issues affecting the business. I invite you to reach out if my team and I can be of service to you.

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