03

Sep

2020

Special Report: How to Manage Cash Flow

Laura Liewen, CPA, Shareholder, Tax

Special Report: How to Manage Cash Flow

No manager of a small or midsize business would argue about the wisdom of the timeworn saying, “Cash is king.” And that’s the underlying driver of any business, regardless of industry. The irony is that many managers fail to incorporate that essential commandment into their management philosophy.

The proverbial bottom line is that businesses that fail to practice good cash management are unable to compete and are forced to borrow money at exorbitant interest rates in order to stay afloat. And many more have gone belly-up because the amount of cash coming in doesn’t jibe with the amount of cash going out. Prudent cash flow management is one of the most important determinants of success for any business, large or small. It’s a fact (make that a commandment) of business life that ought to be indelibly embedded in the minds of all managers. Yet what ought to be a pivotal business tenet is often forgotten.

A study conducted by financial services company US Bank found that 82 percent of startups and small businesses fail because of poor cash flow management.

And an Oklahoma State University study found that 60 percent of businesses suffer from major cash flow problems. Today, smart cash flow management is more important than ever because customers and clients are taking longer to pay back their loans. It’s no wonder business managers lose sleep worrying about how they’ll pay their employees and vendors.

Stephen Doran, head of finance and administration at Virtuzone, listed “not getting a grip on cash flow” among the four money mistakes that will sink a startup. Said Doran, “The net amount of cash moving in and out of your business is the lifeblood of any startup and must be managed with military precision, particularly in the early stages.”

The three other mistakes cited by Doran that will sound the death knell for a startup are:

  • careless hiring
  • putting too much stock in the power of the handshake, and
  • ignoring the importance of the top line

Cash flow’s importance falls on deaf ears

“Poor cash flow management is causing more business failures today than ever before,” according to Philip Campbell, author of Never Run Out of Cash (Grow & Succeed Publishing). Campbell, a CPA, is also a former chief financial officer of several companies. Countless financial pundits and household-name entrepreneurs have pointed out the importance of paying scrupulous attention to prudent cash flow management. Their critical message is that the most brilliant business ideas since the invention of the wheel have died ignoble deaths without prudent cash flow management.

Why can’t managers of small and midsize businesses get their hands around the fundamentals of prudent cash flow management?

The answer, according to some experts is that managers have a hard time distinguishing the difference between cash and cash flow.

Consider that cash is easily accessible money in the bank. It’s not inventory, property, or accounts receivable (what your business is owed). All of these can be converted to cash. However, it can’t be done immediately to allow managers to pay their employees, rent, or suppliers.

Important lesson for managers: The growth of your business is not to be confused with having more available cash. Your profit is the money your business expects to earn over a specific period of time. Cash is what the business must have available to keep it running efficiently on a day-to-day basis.

It’s vital that managers understand that profits are of little value if they’re not accompanied by positive net cash flow. Profits can’t be spent, but cash can be.

Cash flow defined

Another pressing problem is that many managers lack focus and fail to concentrate their energy on business priorities, according to a Harvard Business Review story about return on management (ROM). In short, they’re spreading themselves too thin by expending energy on too many projects, clients, and goals. Simply, cash flow refers to the process of moving cash into and out of a business. And monitoring cash inflows and outflows ranks as one of the managers’ most critical tasks. For example, cash outflow includes the monthly checks managers write to pay salaries, suppliers, and creditors. And inflow includes the cash received from customers or clients, lenders, and investors.

Typically, managers concentrate all their time and expertise on the most critical business issues, such as providing their customers with cutting-edge solutions. But as the business grows and offers new products or services and hires more people to meet market demands, managers direct their efforts away from implementing the company’s core strategies and achieving its most important goals. The dismal results are that the amount of productive organizational energy plummets while the amount of management time invested increases disproportionately. Hence, the company’s ROM is “dismal,” according to the Harvard Business Review.

What Should You Do?

Positive cash flow is the cash flowing into your business, from sales and accounts receivable, for example, which often exceeds the amount of cash leaving your business via accounts payable, monthly expenses, and salaries. Negative cash flow is when cash flowing out of your business exceeds incoming cash. This signals major problems ahead. However, these can be avoided by taking steps to stop the business from hemorrhaging cash by generating more cash and, at the same time, maintaining or cutting expenses. While cash flow ought to be tracked weekly, monthly, or quarterly, it’s important to remember that there are two kinds of cash flows: positive cash flow and negative cash flow.

Seek your accountant’s or payroll bureau’s advice
This is the time when managers should seek their accountants’ input. Accountants have the expertise to guide managers through the process and help them analyze and manage their cash flow so that they’re efficiently controlling the inflow and outflow of cash.

The Small Business Administration strongly advises doing a cash flow analysis to ensure that there is always enough cash on hand each month to cover all of your financial obligations.

On the surface, managing cash flow seems simple. But the consistently high mortality statistics for small businesses, and certainly for startups, dramatically proves that it’s more complicated than most managers realize. Take a proactive stance and seek professional guidance so that your business doesn’t tumble into a cash flow moat.

This is the time when managers ought to seek their accountants’ input. Accountants have the expertise to guide managers through the process.

Your accountant will tell you that profits don’t equal cash flow. Many managers mistakenly think they can monitor their P&L statement and get a toehold on their cash flow. Not true, because many financial variables feed into your cash flow, such as accounts receivable, inventory, accounts payable, capital expenditures, and debt service. Prudent cash flow management requires obsessively focusing on cash drivers in addition to profit or loss.

Author and financial analyst Philip Campbell said, “Knowing whether you earned a profit (or created a loss) is not the same as knowing what happened to your cash.”

Campbell goes on to say: “Profit, as defined by the rules of accounting, is simply revenue minus expenses. Invoicing customers for products or services you sold to them creates revenue. Actually collecting the money on that invoice is what creates cash.”

Take Campbell’s advice and track your cash flow to determine whether you’re creating the type of cash flow your business needs. It also helps you make realistic cash flow projections that you can rely on so that you make smart business decisions. Contact R&A if you need guidance to more effectively manage your business’s cash flows.

About this Author

Laura specializes in income tax return preparation, compliance, and research for individuals and businesses. She also is experienced in preparing compiled and reviewed financial statements, individual and S-Corporation taxation, multi-state taxation, and income tax credits including the R&D credit.