Many businesses make mistakes by following some common cash management theory mistakes. These mistakes can lead to business failure. In fact, 82% of businesses actually fail due to poor cash management.
Introduction to Cash Management Problems
Identifying potential cash management problems before they actually occur can avoid many financial crises in a business. Moreover, the earlier the identification, the sooner one would be able to take action. The article puts together some tips that would prevent cash flow problems.
Some Common Misconceptions
- Profits Are Not Cash: Profit is the excess of turnover over cost and expenses. It is not always cash because a business could have large amounts on its financial statements but nothing in the pocket. This is because revenues are booked at sales, expenses are matched to revenues, and capital expenditures do not count against profit. Thus, a business can incur profits without making any cash.
- Cash Flow is Critical and Not Intuitive: Planning cash flow is not intuitive and is still one of the most significant aspects of managing a business. The biggest mistake that many accountants make is doing the calculation in the head. For example, sales does not necessarily mean money, neither does stock bought now and stored become cost of sales, etc. The concept of accrual accounting must be considered. The three sub-concepts of accrual accounting are accounts receivable (sale and delivery made, but customer has not paid), accounts payable (purchase and delivery made, but payment not made), and expenses (outstanding expenses like professional services, etc., which would eventually be deductible from income). These factors matter as timing of costs, expenses, and sales make a big difference.
- Growth Eats Away Cash: The famous Wall Street saying cautions, "Growth sucks up cash." Seems ironic, but it is true. In fact, most business owners will experience this at some point in their career. To fuel growth, a small business may run into the trap of insufficient working capital. Thus, the quicker the business grows, the greater the amount of financing is needed.
- B2B Sale Eats Away Cash: The basic view of all non-accountants is that all types of sales mean more money. This may be the case in B2C sales but is not the case in B2B sales. This is because once the goods or services are delivered, an invoice is sent. This invoice is usually paid back after a couple of months. Since B2B sales could be big sales and thus great customers, one does not want to leave them.
- Inventory Eats Away Cash: According to Aldisert, “Inventory eats cash, and you can’t get it back until you make more sales." Thus, every dollar owned in inventory is a dollar less in cash. It is advisable to compare the average inventory turnover ratio with the industry average and see if a portion of the burden can be shifted to the suppliers by just-in-time inventory management processes. In addition, if the business has excess inventory, can it be liquidated in a bulk sale?
- Working Capital for Cash Flow Efficiency: Working capital is the accounting term that is used to describe what is left over after the current liabilities are subtracted from current assets. This cash can be used to pay running costs and expenses. Working capital is usually held up in accounts receivables and inventory.
- Accounts receivables: In accounting, accounts receivable is the money that customers owe. Thus, every dollar in accounts receivable is a dollar less in cash.
- Do Not Surprise Bankers: Unlike others, bankers hate surprises. Thus, plan early. It is advisable to get to the bank as soon as you see an issue or opportunity approaching and keep them informed. Many times, they can come up with a shield to protect the business.
- Keep a Check On Things: It is important to keep a check on collection days, payment days, and inventory turnover. Collection days are the number of days that one has to wait to get paid whereas payment days are the number of days that one has to wait to receive payment. Finally, inventory turnover is the measure that describes how long the inventory will stay with you before it is paid.
Clearing these accounting theories could help solve most of the cash flow inefficiencies. However, following some general practices could also help do so. Some of these are:
- Forecasting: Plan a budget and business plan and stick to it. Moreover, alter and update it whenever it becomes outdated. Make sure only actual figures are recorded, and comparisons are made of the actual figures with the plan. It is important to record all variances and the reasons for the variances. It is important to look at all inconsistencies and gauge their implication. Certain software applications, such as Business Plan Pro, can be a big help in keeping track of all of this information.
- Awareness: It is important to be sensitive and alert to market conditions and changes like general interest rates, exchange rates, competitor movements, new competitors, and new technologies and innovations.
- Relationships: Maintain healthy relationships with your bank and other lenders.