Monitor Cash Flow in a Business

Money, which represents the prose of life, and which is hardly spoken of in parlors without an apology, is, in its effects and laws, as beautiful as roses cash flow is nothing more than the movement of money in and out of your business. But in reality it is the lifeblood of your company. You need money to pay your vendors, landlord, and employees in order to stay in business.

As the term implies, cash flow is a moving target; money is constantly going in and out of the business so it can be difficult to pinpoint what your cash status is at any given time. The point of tracking cash flow isn’t to get a fix on your money. Rather, it is simply to make sure that there’s enough money on tap when you need it. Cash flow is not the same as profit. Your business may be profitable, yet face a serious cash flow problem. So it isn’t helpful to focus only on your bottom line and ignore your money supply. In this chapter you will gain a better understanding of what cash flow is all about and how you can analyze your company’s cash flow cycle so you can predict your future money needs. You’ll find out how to plan so that you don’t run out of money, and you’ll learn about a number of ways in which you can improve your cash flow by increasing the money that comes into your business and decreasing the money that goes out.

 Understand the Cash Flow Cycle

How does your cash flow run? As strong and as constant as the Mississippi River or as small and erratic as the little stream that sometimes dries up in the summertime? It is important to know about your company’s cash flow so that you can pay your bills to stay in business.

Cash Flow

Cash flow is the cycle of money going in and out of your company. Usually, it is tracked from the start of the sales process. As a general rule, money flows out during the first phase of the cycle when you incur expenses to furnish your goods or services and flows in during the final phase when you collect the payment for sales. The first phase of the cycle erodes your cash stash; the final phase replenishes it. In other words, the cycle is the time it takes to convert a sale into cash.

Cash Flow Analysis

Do you know how long it takes for money to come in during your business cycle? Without this knowledge you may be caught short of the cash needed to meet your obligations. Take the case of a wedding planner in Seattle. She was great at creating a bride’s dream event, but couldn’t get her mind around cash flow. As a planner she could schedule every component of the event, from the caterer and photographer, to the invitation printer and band. But she failed to take a sufficient down payment from the bride’s father to cover the deposits she owed to each player involved in the affair, leaving her dreadfully short of money to pay her own bills.

Cash flow analysis, which is also called cash flow projection or forecasting, involves an examination of the income coming in and the expenses for which money goes out. It lets you know how much money you’ll need at some future point to meet your expenses. Cash flow analysis also involves the time span in which these items occur. In an ideal situation, you hope your cash outflow will be less than your cash inflow, or will match as closely as possible. If outflow is more than inflow, the wider the gap between these events, the more problematic things can become. Experts differ on how long you need cash flow projections for. Some suggest that six months out is long enough, while others say that two years are mandatory. Obviously, you must find what will work best for you.

Keep a Close Eye on Cash Flow

As the owner of your business, it’s your responsibility to keep tabs on cash flow. Whether you work with an accountant or have a board of directors or advisers, it is ultimately up to you to watch your money and initiate appropriate steps if there are cash flow problems.

In the old (precomputer) days, monitoring cash flow required a time-consuming projection on paper of your money needs, month by month. Doing this work the old-fashioned way—as an exercise— may help you better understand what cash flow is all about. The worksheet in Table 5.1 shows how to perform this analysis for the month of January; you would do the same analysis for each of the other 11 months of the year.

Today, monitoring cash flow can be automated with the use of software designed for this purpose. This cuts down considerably on the time it takes to track your money. If you work closely with an accountant, it is the job of this professional to closely watch your cash flow and to advise you if there is a problem. If you keep your own books, then use software to help you track your cash flow. For example, if you use QuickBooks to keep your books, you can find there two useful cash flow reports: Statement of Cash Flows and Cash Flow Forecast. You do nothing to complete these reports; they are filled in automatically based on the income and expenses you input to your books. All you have to do is be sure that you check these reports regularly to detect problems on the horizon. Other small-business accounting software, such as M.Y.O.B. Accounting and Peachtree First Accounting, have similar cash flow reports and tracking.

Plan for Adequate Cash Flow

Lack of capital is one of the main reasons that businesses fail. They run out of the money needed to pay their bills, and creditors can force them into bankruptcy, requiring them to liquidate the business and distribute whatever money there is to those creditors. It doesn’t matter that there is a hot sales prospect in the wings or that the long-range forecast for the business is great. You need to have adequate sources of money to pay your bills when they come due.

Warning Signs of a Cash Flow Problem

You may not perform an in-depth cash flow analysis each and every month, but you can stay on top of things and avoid a potential problem by doing an easy check at the end of each month. Compare your sales with your expenses. If your expenses, including overhead and purchases to make your sales, are outpacing your sales, you have a potential problem. Danger signs that you may have or are about to have a cash problem include:

_ Bank account balances drop below normal averages.

 Check the balances on your business checking and savings accounts each month to see that they approximate what you have been seeing in prior months. A decline does not necessarily mean you’re in trouble; you may simply have purchased new equipment or made an unusual purchase. But if there is a decline for an unexplained reason, it may indicate cash flow problems (e.g., that your expenses have gone up without the same increase in sales).

_ Sales outlook is dim.

Depending on your type of business, you may continually have sales in the pipeline. For example, if you are an architect, you prepare proposals in order to keep new sales forthcoming. But if you notice that you are doing fewer proposals, you will probably have less sales in the future, something that can jeopardize your cash flow stability.

_ Inventory is building up.

If you find items are sitting on your shelf for longer and longer periods, again you face an issue of reduced sales, which will bring in less revenue.

_ Bills are being paid late.

Many bills you receive are due on receipt or within 10 days. Some bills may give you a 30-day period in which to remit payment. If you find that you are paying these bills in 60 days, 90 days, or longer, you know there’s already a serious cash flow problem.

_ Major purchases are being postponed.

 Your company needs a piece of equipment, but you can’t afford to buy it now because money is tight.

_ Banks are asking for financial statements.

You already have outstanding commercial loans and your lenders are getting nervous, as evidenced by their requests for your balance sheets, income statements, and other financial information.

Improve Cash Flow

Just because you see a cash flow problem looming does not mean you are doomed to experience difficulties. Knowing that there’s a potential problem lets you take steps to avoid a crisis. There are two main ways to improve your cash flow: Increase the amount of cash that’s coming in and reduce the amount of cash that’s flowing out. Both ways help to ensure that you won’t run out of cash. It is usually advisable to tackle both ways simultaneously in order to avoid a cash crunch.

Cash Reserves

If possible (and for many small businesses this is virtually impossible to do), create a cash reserve to help you ride out the lows you may experience. A cash reserve will help you avoid the need to take drastic measures when you experience a cash flow problem.

Warning: Pay Taxes First

In managing cash flow, always avoid problems with the IRS and state sales tax departments. Pay your tax obligations before other creditors, even if the other creditors are knocking at the door. If certain taxes are in arrears (check with your accountant as to which taxes you must pay immediately), these government agencies can freeze your bank account and/or seize your assets. By then it may be too late to address your cash flow difficulties. Once your accounts are frozen, you are no longer in a control of your money.

Strategies for Increasing Cash Inflow

Short of winning the lottery, receiving an inheritance, or depleting your nest egg and putting the funds into your business, there’s no fast and easy way to boost your company’s money supply. Generally, you must look to increase your sales and the collection of payments on these sales. There are, however, other ways to increase your money supply besides boosting sales or putting more of your own money into the business. You can also increase the return on your investments (e.g., interest on money market accounts) and look to find financing from loans, factoring (similar to loans), or grants.

Increase Sales

Obviously, if you sell more, you’ll take in more cash through these sales. Thus, the first and main way to increase your money supply is to take steps to boost your sales, such as changing and rearranging marketing efforts. However, recognizing the old adage “It takes money to make money,” stepping up your sales efforts may initially cost you more than you take in. You’ll have to pay at the start of the sales cycle for these additional costs even though you may not see a return until later on. Thus, it’s a good idea to launch this approach well before you face serious cash flow problems.

Raise Prices

Review your current pricing schedule to see if there is room to make upward adjustments. When was the last time you raised prices? If it was more than a year ago, it may well be time to revise your pricing schedule. What are your competitors charging? You may have fallen behind in pricing by not raising your fees sooner. How is the economy doing? A booming economy can better support your price increases than one in a recession.

Improve Collection of Receivables

You may want to review your collection policies and become more aggressive about delinquent accounts. There are also incentives you can use to obtain payments more rapidly and to avoid slow paying and nonpaying customers.

Tighten or Loosen Up on Extending Credit to Customers

Always try to get cash up front to avoid extending credit to customers. But this is not always possible. For example, if you are a Web designer who contracts to create a Web presence for a company, you may receive payment upon completion of the job. However, you can usually arrange to receive partial payment at stages of the job, including 25 percent to 50 percent of the total fee up front. If you are fortunate enough to be sitting on cash reserves, don’t let them sit idle. Invest (carefully). Make your money work for you, but choose investments that keep your money liquid so you can use the funds as needed at any time. For example, depending on the size of your reserve, you may invest in money market mutual funds or short-term commercial paper.

Find Grant Money

While there may not be an abundance of grants for small businesses, this financing mechanism should certainly be explored. Grants are free money because they do not have to be repaid. To find grants for small business, go to the Small Business opportunities.

Borrow Money

You don’t have to take out a loan and keep the money sitting in the bank to be in a good position to avoid a cash flow disaster. All you need is to put financing options in place so that you can call upon them when necessary. It is always better to make these arrangements when you are in a good financial position than to wait until you really need the money. Consider the following financing options.


Set up a pot of money you can draw upon as needed. A line of credit is a loan you obtain from your bank up to a fixed limit. Usually, this type of loan is a revolving line. As you pay back principal you have more to draw on later on. The line runs for a set term, but can be extended as needed if the bank is agreeable.


If your business has accounts receivable that you must wait to collect upon, consider using a company, called a factor that will buy your receivables (outstanding invoices) from you. Factoring originally was used exclusively in the clothing industry, but today it is being used by many different businesses. The amount you receive has nothing to do with your creditworthiness, but rather the creditworthiness of businesses that owe you money. With factoring, you’ll receive 50 percent to 80 percent of the receivables’ face value up front. The factor then collects on the receivables and remits to you the amount collected, less the factor’s fee. This fee is usually 1 percent to 5 percent of the face value of the receivables. So, in effect, you may receive up to 99 percent of what you are owed, with the bonus of getting half or more of those funds immediately for working capital. Using a factor can be a short-term arrangement to help you over a rough spot. But some small businesses, especially those with continual cash flow swings resulting from seasonal payroll or peak sales periods, may work with a factor as a long term arrangement. Try to obtain “nonrecourse” on the financing so that the up-front money is yours, even if the factor fails to collect on one or more of the receivables. It is usually a good idea to work with a broker specializing in factoring (and who is compensated by a finder’s fee that may be pricey). The broker can shop around for the best factoring company for you and help negotiate the best deal. To locate a broker, do an Internet search in your favorite search engine for “factoring brokers” (make sure you are dealing with a broker and not a factoring company). To check on a factor, contact the Commercial Finance Association (CFA), a trade association for the asset-based financial services industry .


Your vendors may be able to offer you extended payment terms, minimizing your current need for cash. For example, ask for 180- day payment terms. Of course, this will cost you more overall if there are financing costs, but it can help you get over the hump.

Strategies for Decreasing Cash Outflow

You can improve your cash flow by minimizing the drain on your money supply. Usually this means tightening your belt. But there are also a number of creative ways to reduce or delay the outflow of cash from your business.

Cut Expenses

Obviously, the less money you spend, the less you need to take in and the better your cash flow will be. But reducing expenses can be challenging, especially if it requires laying off a valued employee or waiting another year to buy a needed piece of equipment. Examine carefully everything you spend money on; there’s surely room for savings. Try to renegotiate the cost of products or services you regularly purchase since these sellers may be willing to work with you to keep you as a satisfied customer. Buy smarter. The less you pay for something, the better off you will be. Today, you can check the prices of everything from supplies to heavy machinery at online sites and may, in fact, save money by making your purchases online through auction sites or remainder sellers. If you are experiencing severe cash flow problems, you may have to make drastic and painful cuts. You may, for example, need to scale back wages (at least temporarily) in order to avoid firings.

Caution: Do not overlook your obligation to pay so-called trust fund taxes—this is not the place to cut. Trust fund taxes are payroll taxes you withhold on behalf of your employees (income taxes and the employee share of Social Security and Medicare taxes). No matter how your business is legally organized, you are personally liable for 100 percent of these funds. You do not want to pay another creditor over the U.S. Treasury in this case.

Trim Inventory

If you sell goods, you have an inventory on hand for sale. Ideally, you can switch to a just-in-time inventory management system where you do not stock anything until it is needed. You might, for example, be able to arrange shipment directly from a manufacturer rather than warehousing items yourself. But most businesses can’t do this, so you might want to aim for minimizing the amount  of inventory you carry. Again, this is simply a matter of cutting back—ordering less and stocking a smaller variety of items. Of course, you must maintain sufficient inventory to offer your customers a good selection of items and be able to deliver promptly, so scaling back requires some finesse. Also work with suppliers to increase delivery time for your receipt of inventory items so you can cut back on your stockpiles.

Delay Paying Your Bills

You don’t want to fall delinquent on your obligations—doing so can cost you interest charges, damage your credit rating, and cause you to lose standing with existing vendors or suppliers. But you don’t have to pay immediately. Take advantage of the payment terms. For example, if you have a 30-day window, remit payment on the 27th day. Pick and choose carefully which creditors to pay if funds are tight, paying careful attention to interest rates that may apply. Use online payment options to finely time your payments. Since transfers are instantaneous, you can send payments at the very last minute. If you must be late, talk with your suppliers to gain their understanding. Try to arrange for extended payment options, even if it costs you some interest charges, if you are experiencing a temporary cash crunch.

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