You can be on Entrepreneur’s cover!

How to Anticipate Cash-Flow Problems Do advance planning to avoid a crash course in the lesson you don't want to learn the hard way.

By Tim Berry

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

Why don't all business owners watch cash flow constantly? I recently caught up with a 2007 survey of business owners showing that only about one-half said they track cash flow regularly.

Business experts constantly warn about cash flow. So why did so many business owners say they didn't watch cash flow?

Many business owners are just checking their profit and loss tallies regularly, thinking in terms of sales and expenses but not cash flow.

Related: 10 Ways to Keep Your Company's Cash Flow Alive

The challenge for most: Many business owners think in terms of sales, costs and expenses. But business cash flow has all to do with timing and delays. So having a profit doesn't mean they have money in the bank. So they must plan, forecast and manage cash flow to be sure that they don't run out of money.

The cash-flow free pass: For some consumer-oriented service businesses, the customers pay immediately by cash, check or credit card when they receive a service. Some lucky companies may not even have to spend money on product inventory, assembly and storage and don't have heavy debt to repay. If that's the case, then as long as the company owners take in more sales than they pay out in expenses, they will have money in the bank.

These business owners are structurally better off than many others because they don't have the same working capital vulnerability. Still they should be careful, watching their cash balance carefully. It's important to forecast sales, costs and expenses and track the results to catch changes fast.

Two factors make businesses especially vulnerable to cash-flow problems:

Related: 5 Must-Track Metrics to Keep Your Startup Alive

1. Companies involved with business-to-business sales find that their customers aren't paying when they get the product or service. Instead, the businesses send them an invoice and the customers pay in few weeks or months later. So business owners can't track sales alone; they have to track sales on credit, which result in accounts receivables, not money in hand. (This does not refer to credit-card sales, whereby payment arrives in a couple of days.) Every dollar in accounts receivable is a dollar less in the bank.

A business owner might take a look at the sales tally at any given moment and a certain transaction might be included in the tally of sales but the company doesn't have the money. Can it cover costs and expenses in the meantime? That takes money. Call it cash flow or working capital: The company owner needs to manage expenses while waiting to get paid.

2. Creation of product inventory means that money is tied up buying stuff before the owner has the chance to sell it. A bookstore owner, for example, has to purchase inventory way before someone walks into the store. A manufacturer has to buy raw materials and pay for assembly. Any product business involved with making sales through stores has to deal with paying for packaging and shipping before making a sale. There's also the costly creation of prototypes and new versions. Even a software company like mine has to develop a product, do the design, coding, testing and more testing before making a sale.

All these product costs take money that's often spent long before the sale. The money doesn't end up in the profit tally until the sale is made, though. The book a customer buys for $10 may have cost the store only $5. But that $5 might have left the store's bank account months ago and only shows up in the bank account after a customer buys the book.

In this case, the business owner spent the money already but checking on the profits ignores the real cash flow.

The bottom line. For anyone selling business-to-business products, having profits on paper doesn't guarantee having cash.

Many profitable businesses have run out of cash. They didn't have enough money to cover costs and expenses because they were waiting too long for customers to pay them or they had extensive funds tied up in unsold inventory.

The best and the worst cash-flow lesson I learned not during my two years of business school. The lesson came when my company's product took off. Monthly sales quadrupled over a few short months. And while everyone at my company was celebrating, the enterprise nearly went broke.

It was the best lesson ever because of the teaching power of hard knocks. And it was the worst lesson ever because it nearly killed the company. Thank goodness I had some home equity left over to support two new mortgages. Without that house value to use as collateral to back a commercial loan, my business might have missed its payroll, failed to attend to critical bills and gone under.

Related: How to Be Smart About Your Spending in 2014 (Infographic)

Tim Berry

Entrepreneur, Business Planner and Angel Investor

Tim Berry is the chairman of Eugene, Ore.-Palo Alto Software, which produces business-planning software. He founded Bplans.com and wrote The Plan-As-You-Go Business Plan, published by Entrepreneur Press. Berry is also a co-founder of HavePresence.com, a leader in a local angel-investment group and a judge of international business-plan competitions.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Editor's Pick

Business News

From Tom Brady to Kevin O'Leary – See Who Lost Big in the Wake of the FTX Crypto Collapse

The crash exposed an $8 billion hole in FTX's accounts, leaving investors and customers scrambling to recoup their funds.

Business News

This Highly-Debated Piece of Cinematic History Just Sold For Over $700,000 at Auction

The wood panel from "Titanic" is often mistaken as a door. Either way, he couldn't have fit. (Sorry.)

Fundraising

Avoid These 9 Pitch Deck Mistakes When Asking Others For Money

Crafting an efficient pitch deck requires serious effort, but at least it's not wandering in the dark since certain rules are shaped by decades of relationships between startups and investors.

Business Ideas

63 Small Business Ideas to Start in 2024

We put together a list of the best, most profitable small business ideas for entrepreneurs to pursue in 2024.