Build Your Business: Five Steps to Stronger Cash Flow

What exactly accounts for the radically different fates of so many seemingly profitable businesses? They all appear to have everything going for them — smart owners, great locations and a strong market — but only a few thrive, while many more limp along, or simply struggle to survive. Is it simply luck?

There are, of course, many possible answers, but more often than not, a business owner’s understanding of cash flow management provides a telling explanation of a company’s fate.

Many small business owners, particularly those opening a business for the first time, tend to gauge the health and success of their businesses on things such as profit margins, sales growth or strong customer loyalty. While these are critical metrics, the reality for any business is that balanced cash flow is an equally important indicator of well-being. This is because cash pays the monthly bills, covers the payroll and can be invested back into the company to support expansion.

Cash flow management is often a cause for entrepreneurs’ insomnia with one in four small business owners citing cash flow issues as something that “keeps them up at night,” according to the Fall 2007 Small Business Monitor, a semi-annual survey of business owners conducted by American Express OPEN.

In fact, nearly half of entrepreneurs report experiencing cash flow issues, with those affected often accessing their personal or private funds, using a line of credit, putting off purchases or using a charge card or short-term loan in order to address their concerns.

To avoid the perils of uneven cash flow, small business owners simply need to keep the following five basic steps in mind to measure, monitor and manage the cash that moves in and out of their businesses:

First, know exactly where you stand with a cash flow statement. Poring over an income statement alone won’t shed light on a company’s cash flow situation. That’s because income statements only reveal sales, expenses and profits at a given moment. A cash flow statement, however, shows the movement of money in and out of a business over a specific period of time, whether a week, month, quarter or year.

A cash flow statement will show not only what cash is left at the end of the month but also the amount that entered and left the business. In other words, it will make it easy to see whether you’re adding to your business’ reserves over time, or slowly eroding them. It’s important to see this before reserves get low; otherwise, a business can find itself in a bind when it comes to covering unexpected expenses, or if business slows.

There are some simple balance sheet calculations that can help a business owner understand his or her cash flow situation. One important calculation is the number of days it takes to turn inventory. This is particularly important for quick-lube businesses, for example, where a fairly large and costly inventory of oil, filters and other supplies is required.

But even for carwashes, where the core business requires a relatively low inventory, it is important to avoid tying up cash needlessly in inventory for supplemental sources of income, such as car accessories and other retail items.

If tracking cash flow seems daunting, then take the time to speak with a savvy advisor, your accountant or a financial consultant because there’s no replacing the knowledge you’ll gain from these basic figures and calculations. Consider the cost of doing so an important investment in your business.

Understanding how cash flow problems occur is your best defense. Cash flow problems can arise from either end of the business cycle — spending or receiving. And, of course, both sources can present problems in combination, which can rapidly put a business in financial crisis.

Looking at the spending side of the equation, consider periods of growth, for example, when a company may need to invest in new equipment or additional inventory to thrive. It’s necessary to expand to take advantage of good market conditions, but growth expenditures can quickly deplete precious cash reserves. Businesses also need cash to spend on a variety of routine operational costs, such as utilities and equipment maintenance.

On the other side of the ledger, there must be a steady flow of money coming into the business or reserves will run dry just from covering basic expenses. An auto detailing shop that takes on a big job, for example, must bear the expense of labor and supplies until the job is completely paid. A few large jobs with delayed payments for just one week can quickly cause cash flow problems for a small business.

While collection usually isn’t an issue for carwashes — unless perhaps they rent space to another business — cash flow is no stranger. A summer drought with water restrictions for just a week or two can also cause cash to dry up.

Understanding where cash flow problems originate can help you avoid them before they become an issue. If you know, for example, that your company will soon be facing rapid growth, slowing sales due to seasonal fluctuations, or long collection cycles, you can take measures to combat these situations.

An ounce of prevention is worth a pound of cure when it comes to cash flow problems, so get serious about minimizing your business’ fixed expenses. A company should be big enough to cover only its most predictable, recurring needs. Find creative ways of handling peaks in demand without hiring additional staff.

An auto detailing shop could, for example, outsource certain jobs, while a carwash might choose to hire students to lend a hand in busy periods. These kinds of “right-sizing” strategies go a long way in minimizing cash needs.

When making purchases for your business, look for non-cash ways to get what you need. Credit-card rewards programs can be effective cash substitutes, and bartering with other businesses for products or services may be an option.

Of course, many expenses must be paid in cash, such as the upfront costs of inventory. One way of evening out cash flow is to delay payment through trade terms with vendors. Try to negotiate terms that will allow you to defer payment beyond the typical 30 days and reward you with a discount when paying early. Larger, more established businesses will have an easier time negotiating these terms, but small businesses with a good reputation for timely payment will have some room for negotiation with vendors.

One way to gain trade-like terms from vendors and eliminate the need to negotiate is with the PlumCard, a new financing tool from American Express OPEN which offers small business owners trade-like terms on virtually all purchases. It was designed specifically for car-care services and other small businesses that face high upfront costs and often experience variable cash flow.

The PlumCard provides business owners with flexible trade-like terms with the option to defer payment for two months, interest free, or receive early pay discounts for just about everything purchased with the card.

Efficiently managing accounts receivable also plays a critical role in maintaining healthy cash flow. To ease the accounts receivable process, make sure what you’re owed arrives on time by setting clear payment terms and expectations. It’s important to be diligent on follow-up and critical to stay on top of collections. Simply knowing when you can expect payment is half the battle.

Despite the best of plans and most diligent cash management, there may be times when your company needs extra cash, so it’s important to have tools on hand for when cash is scarce. You should make sure your company is prepared with several sources of financing in advance. One of the reasons it pays to plan ahead is that some financial institutions may be more likely to extend lines of credit or loans when your company is in good financial health, and less likely when cash flow problems have already taken a toll on your finances.

When seeking financing, be careful not to overlook special lending programs for which your business may qualify, such as those designed to assist small businesses owned by women or minorities.

Once you have credit available to you, use it wisely. Short-term financing options, such as lines of credit, short-term loans or credit cards, are best used for short-term cash needs. Likewise, long-term or secured loans should be used for the purchase of long-term investments.

Consistent growth is the best way to smooth out bumps in cash flow.

When growth opportunities arise, plan carefully with an eye on cash flow projections. Make a conscious decision about how much you have to spend to reach your goal and how long it will be before you pay back the debt. Every investment, whether in inventory, people or equipment, should have a clear return. Make sure each earns a profit, but also look at how long it will take to collect them. Likewise, if you look at each customer as an investment with a scheduled return, you’ll not only improve cash flow, but profitability too.

Entrepreneurs go into business because they thrive on the excitement of a good challenge, but even the most daring entrepreneur can do without the stomach-churning, rollercoaster ride of variable cash flow. Rid yourself of these avoidable bad times by keeping an eye on cash flow, and enjoy the real thrills and excitement of owning your own car-care business.

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