How to Anticipate Cash-Flow Problems
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.
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:
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.
Entrepreneur Editors' Picks
'No One Believed' This Black Founder Was the Owner of a Liquor Brand in 2012. He Launched to Great Acclaim — Then Lost It All. Here's How He Made a Multi-Million-Dollar Comeback.
Inspired by Elon Musk's Twitter Takeover, Here Are 10 Marketing Tactics That Will Help You Make the Most of Big Changes to Your Company
These Brothers Transformed a High School Project Into the Largest Online Soccer Retailer of All Time. Here's What the World Cup Means for Business Now.
'I Just Lost All My Life Savings': Michigan Woman Lost $15,000 in Facebook Marketplace Car Scam
This Founder Was Dismayed by Food Waste in the Restaurant Industry, So She Started a Zero-Waste Grocery Line That Now Caters Events for Nike
Netflix's Secret Club Allows Members to Preview Content Before Anyone Else — But There's a Catch
Franchising Could Be the Secret to Reaping the Rewards of a Down Economy. Here Are 5 Reasons Why.