Cash Flow Management

Cash flow management is key to success for many new and growing small/midsized businesses. Cash is the fuel that makes a business work; hence, these businesses should be managed with a primary focus on cash/cash flow rather than income or other financial measures.      According to the U.S. Small Business Administration, nearly half of all small businesses fail within their first five years. A big reason for this appears to be cash flow mismanagement.

Hal SheltonIn this column I will share answers from Hal Shelton, a SCORE mentor, regarding some key cash management questions.

1. Question 1. Why is effective cash flow management so critical to a small to midsize business, especially one that is new or growing?

Having too little or too much cash is often cited in the top reasons why a small business fails. Good cash management brings stability to a business, which provides the ability to choose customers, vendors and staff, negotiate the best terms, plan for growth, etc. Cash resources available to new small to mid-sized enterprises (SMEs) are usually tight, so you need to know can you meet this week’s payroll; pay vendor bills and take advantage of any discounts offered; take on new work, projects, territories, etc. to facilitate your company’s growth; and pay the founder/CEO. You should know the amount of cash you have in the bank at the end of every day.

Fundraising is a very time-consuming process and is usually disruptive to managing the ongoing business. Once you have raised funds, use them wisely so you can spend time managing and growing the business, rather than being on a continual fundraising treadmill.

Question 2. What are the top misconceptions people have about cash flow management?

  • Misconception #1. Cash flow management is a foreign language, and you need special skills to calculate it.  In fact, cash flow is easier to calculate than income with all its accounting rules. You have the cash, or you do not. Forecast the cash coming in and the cash going out, and you have it. Of course, you need an understanding of your business and what makes it tick. But you need to know your business economics to be an effective and profitable entrepreneur.
  • Misconception #2. You only need to prepare a cash flow once a year when you plan your budget.  Not true. You need to project cash flow every month and have it extend 12 months—a rolling 12-month forecast. If the company has cash issues, the cash projection might be every week—will you be able to make payroll, etc.?
  • Misconception #3. If your company is profitable, you can’t have a cash flow problem.  Not true, see response to the next question.

Question 3. Can a business that has many customers and is making a profit still experience cash flow issues?

It is often growing companies that are surprised when the cash crunch comes. As you grow, you will need to build more product for a product business or hire staff for a service business—in either case, it is in advance of making sales. Therefore, you are spending cash before getting paid.

Further, giving your customers credit terms exacerbates the situation; you have made the sale, but it might be 30 or 60 days before you receive the cash from the sale. You can talk about sales made, bookings, revenues, etc., but these are not necessarily cash received at the same time.

Question 4. What are some common mistakes business owners make when it comes to cash flow management?

  • Mistake #1. Not having a monthly cash flow forecast extending 12 months forward.  It’s important to be able to see when cash shortfalls might be occurring so you can take effective action. Unless you are funding the business from your personal account, most other means to obtain funding take some time—a bank term loan, online lending, crowdfunding campaign, angel investors, etc. If you do not give yourself time to obtain outside funding, then you will have no option but to fund the company yourself—or accept whatever terms are demanded by a funder.
  • Mistake #2. Founder/CEO thinks that cash flow is the accountant’s job.  The accountant reports on past activities. The CEO makes things happen going forward and needs to have top of mind what the cash impact of her decisions/actions will be.
  • Mistake #3. Not having a “Plan B”.  If there is a cash crunch, how will you cope/handle it? What staff and expenses to cut, which vendor invoices to delay payment, and all other measures to conserve cash? Of course, you’ll need to update/fine tune the list if/when a cash crunch occurs—but it’s good to have planned in advance.
  • Mistake #4. Thinking that you can never have too much cash.  Too much cash is one of the reasons why companies fail. Maybe it is because you are too conservative, not willing to take some risk in new opportunities. Or if you go too far, you might not make well-thought-out investments/expenditures (e.g., hiring staff well before have product/service sales).

About the Author(s)

Dean Swanson

Dean is a Certified SCORE Mentor and former SCORE Chapter Chair, District Director, and Regional Vice President for the North West Region, and has developed and managed many businesses. The Rochester Post Bulletin publishes his weekly article on a topic geared toward the small business community. The articles here are printed in their entirety.

Certified SCORE Mentor for the Southeast Minnesota Chapter

Key Topics

Cash is King