Don't Let Your Cash Flow Down the Drain
This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.
Wouldn't it be cool if there was a gizmo that would let you see cash flow?
If I were building one, I'd have a wire for "cash in" and one for "cash out," plus a display that would glow different colors ranging from green to red depending on the relative volume of cash in and out. Of course, since we are making this up, we can have anything we want so I'd have a switch to select next day, next week, and next month cash position.
Our fictitious high tech product could, of course, be replaced with an old oak washtub. Water comes in the faucet, water goes out the drain. If the amount running in matches the amount going out, the water stays at an acceptable level. Water level starting to drop? Turn up the faucet. Still going down? Get a bigger pipe or put a rag in the drain.
But bright shiny objects that blink are lots more fun, if not as quaint, so we'll stick with that.
Of course, the sensors necessary to make our device work don't exist, but if someone could build such a thing kids, parents, small business owners, and mega-corp financial executives would love it because it would give them real time information on the health of their finances.
Just received your allowance and want to buy some new comic books? Might not be a good idea. This thing would be flashing red because you still have to pay back your pal who loaned you lunch money last week.
Business owners would have a tangible way to watch that cash coming in from sales, loans, and equity and see that it has to equal or exceed cash going out for raw materials, loan payments, equipment purchases, salaries, and other ongoing business expenses.
With our fantasy cash flow management device (would Apple call it the iBank?), people would be able watch the results when they take steps to speed up cash coming in and slow down cash going out.
Having more cash coming in is obviously good, but what's perhaps not so obvious is that money owed to you — which is nice to have on the books — isn't as nice to have as money in the bank. If you can find a way to start it coming in faster, it's the same as opening the spigot.
How fast cash comes in can be improved by reducing the trade terms extended to customers, billing promptly, or requiring progress payments and deposits, reducing and preventing bad debts, making deposits quicker, and even raising new money. How fast cash goes out can be improved by asking for longer trade terms, securing long term debt to lower monthly payments, or reducing inventory or speeding up its turnover.
Assuming you're already working as hard as you can at peddling your wares, the quickest way to increase revenue is to raise your prices. Even though you may lose customers at the higher prices, you'll probably still make more money.
Once you've done everything you can to boost revenue, you'll want to look for ways to reduce expenses. The tactics you'll use will, of course, vary with the severity of your cash flow problem, but it's usually best to focus your attention on your company's largest expenses first. Blanket cost-cutting measures, such as chopping every item by 10%, rarely work.
Instead, you should focus on items that will reduce the ratio of expenses to sales. Wherever possible, you want expenses to vary with the level of sales. So, for example, commission-based salespeople are better than salaried ones — at least from a cash flow perspective.
One thing you don't want to do is to reduce the wrong costs. For example, a cut in your advertising budget will reduce expenses, but it's likely to reduce sales too. In the long run, the ratio of expenses to sales will be worse.
In short, your cash management tactics should:
- Speed up cash coming in,
- Slow down cash going out,
- Increase cash coming in, or
- Decrease cash going out.
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