Cash Flow Keeps Vital Signs Strong

Just like circulation is vital for a healthy body, cash flow is essential for a healthy business.

As several area accountants noted, cash is so vital to the functioning of small businesses it spawned the mantra “cash is king.”

This is especially true for small businesses, and never more so than during an economic downturn. Residential building in Northwest Arkansas has slowed significantly from two years ago, a development that will surely cause a pinch for some.

But there are practices business owners can apply from an accounting and tax standpoint to lessen the impact of a tough economic climate.

If a business’s accounts receivable are stagnant, its inventory is bloated and its capital expenditures are out of control, cash flow is sure to suffer.

When liabilities come due and cash isn’t coming in, it’s often because of poor debt structure.

In addition to keeping cash flow and debt structure in line, it’s also important for business owners to know how their operations compare to similar outfits and where they fit into the local economy.

To this end, many accounting firms subscribe to services offered by agencies such as The Risk Management Association, which produces benchmark studies on businesses of all sizes.

“Once you know where you fit, you can assess where you’re at in the local economy,” said Mark Lundy, managing partner of Lundy Allard & Co. PLLC in Rogers.

These benchmarking guides help accountants like Lundy show business owners how their gross margins, expenditures, inventory, administrative expenses and other factors compare with similar operations.

They can be useful to provide a general view of how a business should be doing.

But when it comes down to brass tacks, business owners must often stray from the benchmarks and base their assessments on the local economic climate.

Flow Fundamentals

For small businesses, a crucial part of weathering a downturn is a matter of following the accounting fundamentals. Although credit is undoubtedly important, accountants are always interested in cash flow.

“Cash flow is simple,” Lundy said. “You want to keep more than you spend.”

There are several factors affecting this basic tenet, though, and these are points where many small business owners get stuck.

Assets drive sales. If a business doesn’t have much to offer in the way of products, its cash flow suffers. At the same time, too much stale inventory can eat away at cash, so finding a balance is necessary. This is often harder for small businesses than for retail giants such as Target and Wal-Mart, which have inventory down to a science.

“Don’t let inventory get too high,” said John Ervin, of Ervin & Co. CPAs PA in Fayetteville. “If you do, you’ve got cash sitting on your shelves or in your parking lot, not making you money.”

Another area where cash flow can suffer is if a business’s accounts receivable are slow. Staying on top of accounts receivable is critical because they get more difficult to collect as time goes by, Ervin said.

Most businesses allow 30 days for payment, but many offer discounts if customers pay early.

“Remember that your accounts payable is somebody else’s accounts receivable,” Lundy said. “Take advantage of the discounts offered.”

Other areas to watch are overhead and administrative costs, gross margins and capital expenditures. Sometimes adjusting costs in these areas can make the difference between profit and loss.

Optimizing gross margins is usually a matter of either raising prices or shrinking costs.

As far as administrative expenses go, it’s important to make sure that everyone working in a business is keeping busy all the time, Lundy said.

As for capital expenditures, if a business owner has gear-head tendencies, the desire to have the newest and latest can eat away at cash. Each new investment must be evaluated to make sure it is absolutely necessary, and existing infrastructure needs to be either fully utilized or liquidated.

When it comes to lines of credit, keeping in touch with one’s banker can’t be overemphasized, Ervin said.

“Stay in close contact with your banker and let them know where you are,” he said. “They get nervous if they haven’t heard from you.”

Making sure all of the records are tidy is something Lundy and Ervin are emphatic about.

“Keep good balance sheets, because that is the photograph of your business we look at to compare it with benchmarks,” Lundy said.

Real Ripple

Whether Northwest Arkansas is experiencing a true economic downturn or a mere market correction has been debated in recent months, and could be chalked up to a matter of semantics and perspective.

But one thing nearly everyone can agree on is that residential and commercial construction has slowed considerably from its pace of two years ago.

This has had a ripple effect on businesses outside of the real estate and construction industries.

A lot more goes into building a subdivision or shopping center than just raw materials. Besides the bricks, mortar and metal siding, workers on jobsites consume chips, sodas, gasoline and many other products in the course of a workday.

Fewer building projects mean fewer workers and less demand for, say, bags of ice.

Ervin recently spoke with a client who owned a convenience store. The storeowner told Ervin he was selling far fewer bags of ice than this time last year.

The current factors affecting the real estate market in both Northwest Arkansas and the rest of the country are causing many small business owners to feel a pinch.

“We’re all having to share in this a little bit,” Ervin said of the slowdown. “We’re just not selling as many bags of ice anymore.”

Ervin has seen three downturns in his 30 years of experience in Northwest Arkansas. He doesn’t expect substantial relief from the current market correction until the first quarter of 2009 at the earliest. But conditions aren’t as bad as they were in the late 1970s and early 1980s, when interest rates soared as high as 22 percent, he said.

“Interest rates aren’t that high, and the overall economy is strong,” Ervin said.

Taxes Back

And for off years, many CPAs can offer relief through taxes.

If net losses for a year are inevitable, business owners can opt to file a claim to carry back or carry forward those losses with the IRS. This allows for either refunds on taxes paid in prior years or write-offs for taxes to be paid in the future to compensate for losses, said Tony Uth, a CPA with Tullius Taylor Sartain & Sartain LLP of Fayetteville.

In the event that a business owner has net losses for a year, he can file what is known as a carry-back claim with the IRS.

Form 1045 is an application for tentative refund for net operating loss. It allows for a refund of taxes paid in the previous two years.

For instance, if one had paid taxes on income of $100,000 for two years, but had losses of $100,000 the third year, the IRS might refund all of the taxes paid from the prior year.

Business owners can also choose to carry losses forward and apply them to future tax write-offs for up to 20 years, Uth said.

If losses for are anticipated, but could be offset by a big order or job near the end of the year, it might be in the owner’s interest to push that job back until the next year.

This would ensure that losses – and therefore any possible refund – would be higher.

Uth doesn’t typically see many carry-back claims in Northwest Arkansas, usually about 10 a year.

But when he was working in Tulsa during the oil bust in the mid ’80s, he saw a substantial number of the claims.

“In an area where people are losing money it’s common,” he said.

Whether Uth will see an increase of claims in the coming months and years is anyone’s guess. But it is an option business owners should be aware of, he said.