One of the questions that I as a CPA get the most from my clients relates to the cash flow concerns of their businesses. Most of you will agree that having sufficient cash-flow is essential to the success of any sustainable business. According to a study performed in the U.S., 82 percent of business failures are due to poor cash flow management. To prevent this from happening to your business, here are 3 critical cash flow rules to remember.
1. Profits Do Not Equal Cash: You can make profits without making any money. Here’s why: Making the sales doesn’t necessarily mean you have the money. Your customers don’t typically pay you immediately when they buy from you. If you are selling a product or service, you will generally incur expenses before delivering the product/service to your customer. Until the product/service is delivered to the customer and the payment is received, profits do not equal cash.This is a key concept to understand in cash flow management.
2. Holding Inventory Sucks Up Cash: You have to buy your product or build it before you can sell it. Even if you put the product on your shelves and wait to sell it, your suppliers expect to get paid. Here’s a simple rule of thumb: Every dollar you have in inventory is a dollar you don’t have in cash. Using a key indicator will allow you to determine how efficiently you are holding your inventory. “Inventory turnover” is a measure of how long your inventory sits on your working capital and clogs your cash flow. If your business requires the holding of inventory, reduction of these holding costs are essential to your cash flow position.
3. Cashing in On Receivables: The most cash flow efficient way to get paid is to receive pre-payment from your customers. If pre-payment for goods/services cannot be obtained, then it is important to keep a tight watch on your accounts receivables. In a typical business, you deliver the goods or services along with an invoice, and the customers pay the invoice at later time. The money your customers owe you is called “accounts receivable.” “Collection days” is a measure of how long you wait to get paid. Here’s a shortcut to cash planning: Every dollar in accounts receivable is a dollar less cash.