It’s the last envelope in the pile that makes you groan.
You tear it open rather ungraciously. Who still sends invoices in the mail, anyway? Of course, you go straight to your bank account and check the balance, just to be sure you have enough cash to cover the bill.
You’ve just made a mistake that so many business owners make every day.
The bank account is a lie.
The account balance a misleading tale of wonder.
A false messiah promising you great riches.
But why am I saying this?
Cash Balance vs Cash Flow
First, let’s talk about the difference between Cash Balance and Cash Flow.
Cash balance is simple enough, it is the amount of cash you have on hand. You can find your cash balance on the balance sheet, one of the three big financial statements every business should compile regularly.
Cash flow, on the other hand, describes the movement of cash.
Every business goes through cycles, they buy stuff—accounts payable, pay for stuff—cash flows out, and then they sell stuff—accounts receivable, and then they collect the money—cash flows in. Find this information on the Statement of Cashflow.
Look at your bank account, and you’ll only see your bank account balance.
What you won’t see is the bills that are coming due. Imagining that all the money is yours, you excitedly spend, invest, or take an owner’s draw. The next day a bill comes due, and you have nothing to pay for it with!
Think Back, Plan Ahead
The Statement of Cashflow will only show you what happened in the past.
But it is a great resource to demystifying the patterns of your business’s cycles. Keep a close eye on your balance sheet for the line items that sum up your Accounts Payable and Accounts Receivable. Your accountant might simply call them “payables” and “receivables” or “AP” and “AR”.
These show you how much cash is already owed, and how much cash you can expect to arrive soon.
Now you can start to plan ahead and manage your cash in such a way that you always have enough available to pay your bills on time and extra cash for emergencies or unexpected delays. But looking at a single moment in time can still give you a false picture.
Here’s where understanding your cash cycle really comes into play.
Powerful Projections
A financial analyst can help you build a rolling cash flow projection.
This is a super powerful tool for bigger businesses with more complex operations.
Calculating many variables, such as your sales forecasts, inventory levels, collection terms and practices, debt, and much more, the model projects out (almost) the exact amount of money that will come in and out of the business. It will tell you how much cash you will need and expose tight spots before they happen.
Typically, businesses use a rolling 13-week cash flow projection.
This means the model “rolls forward” and refreshes every week, always showing the predictions for the next 13 weeks—pretty much a financial quarter—ahead. Keep in mind this model is never perfectly accurate and gets better the more you use it.
How to Improve Cash Flow
Unhealthy cash flow can drown even the most profitable company.
While healthy cash flow can save a company from complete disaster.
So how do you improve your cash flow? Here are some basics:
1. Negotiate more time to pay your bills.
2. Collect on your sales as quickly as you can.
3. Improve your inventory turnover speed.
4. Make more sales.
5. Reduce costs where you can.
6. Open a line of credit.
7. Bring on new investors.
Some of these seem very obvious, but the general goal is to get more money quicker, and pay the least money and as late as possible. This means you’ll have the most cash on hand to work with at any given time.
This cash is what you can use to invest in and grow your business.
Be careful not to go too crazy, demanding unreasonable terms from your vendors or clients will damage those relationships and while your business gets cash now, it will sink like a sieve in the sea in the long run.
Debt as a Strategy
Having a line of credit is very important.
It allows you to have cash available when you need it most, without having to make the interest payments until you actually take it out. Seeing as cash is so crucial to growing your business, it can be very tempting to borrow loads of money from banks or investors.
However, debt comes with great risk.
It is called over-leveraging and it can destroy your business as surely as running out of cash. Never borrow money without a solid plan to use it strategically. Be proactive and use projections so that you are not forced to borrow money out of urgency, with no time to plan and prepare.
Some of the biggest companies dominated by prioritizing cash over profits.
Think Jeff Bezos of Amazon, and Travis Kalanick of Uber. However, some of the biggest companies were destroyed by over-leveraging and poor planning. Think of Toys “R” Us and Blockbuster.
Proactive vs Reactive
Ultimately, the key to managing cash flow is to plan ahead.
The companies that understand their cash cycles and invest in projections are well equipped to avoid surprises, grab opportunities, and respond with wicked speed to the twists and turns on the ride to massive growth and remarkable success.
I hope this article smooths some bumps on your journey, safe travels!
