Profit and cash flow are not the same thing. In fact, more businesses fail from a lack of cash flow than from a lack of profits.
So, don’t become one of the statistics: a business that goes broke while recording a healthy profit.
The most common reason for a discrepancy over cash flow and profit is the difference in timing between the making of a sale and receiving the money.
Consider a business that sells something on credit but doesn’t collect the money until the next month or maybe even much longer than that, depending on the business terms or collection habits. In these cases, that revenue from the sale may be accrued on the income statement, but in reality the business does not have that money to spend.
But cash outflows to suppliers, staff, capital and interest repayments on loans, taxation and capital expenditures do not stop and wait for the cash to come in.
Forecasting and cash flow management are two critical areas of focus to ensure your business will not become another statistic.
Cash flow forecasting is the first critical step.
Cash flow planning includes forecasting and tabulating cash inflow relating to sales, new loans, interest received from financing activities and then analyzing, in detail, the timing of expected outflow to suppliers, wages loans repayments, tax payments, etc.
Avoid overstating sales forecasts and inaccurately predicting flow costs. Be aware of debtors’ trends and performance and never make overly optimistic assumptions regarding loans and credit availability.
Ongoing cash flow management should become a daily management task. Below are the four areas of critical focus:
• Accounts receivables: Collect, collect, collect. Invoice immediately after the work or service has been completed. Require upfront deposits or payment in advance where possible and have your customers pay by credit card or obtain authority to debit their bank account.
This way, payments are processed immediately and there is no waiting period.
• Accounts payable: Maintain a budget and manage it. Pay your bills promptly.
After you build a history of payment, negotiate extended payment terms to maximize cash retention. A supplier often will give a good customer 30- to 90-day terms.
• Focus on sales and marketing: A regular and dependable volume of sales is a major help to cash flow planning.
Systemize your sales and marketing as much as practical to ensure you have a regular level of leads and a strong conversion rate. Offer rewards for early payment and develop a VIP program for good customers that could drive sales now.
• General cash management/cost reduction: Reduce direct and indirect costs. Keep overheads to a minimum.
Before purchasing, set increased sales goals to justify and fund the expense. If possible, reduce inventory levels and negotiate the volume discounts available on smaller quantities.
Review your cash position every week and review your profit and loss statement monthly. Always establish a line of credit with your bank before you need it.
Use good judgment when establishing internal controls for handling cash. Use different people to reconcile the activity when depositing cash or checks.
Remember: Cash flow is king. With the tough economy of the last five years, cash management can make or break a business.
Most small businesses are undercapitalized, so cash flow management is a critical piece to the financial health of the business.
No one will argue the simplicity of this concept, but assuring that these cash inflows and outflows are managed is the fundamental responsibility of the business owner and one that cannot be ignored.
So, become cash happy.
Michelle Landis is a business coach and owner of ActionCOACH of Greater Lehigh Valley/Berks. Her mission is to create success for businesses through focus, accountability and results. For more information, visit www.actioncoach.com/michellelandis.
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