Cash is King

guest commentary by David Potts

If you are new to owning your own business, one of the business terms you first learn, intimately, is “cash flow”.

Cash is king. You might have started your business to change the world but without cash you will fail. And failure is always an option whether your business is in the start-up stage or the mature stage like General Motors. Just remember your business is not too big to fail. The government will not bail you out. On the contrary, it’s more likely that future regulation of business and increasing taxes will make it more difficult for small businesses to succeed, or at the least make it more costly to run.

So what does a business owner need to know about cash flow?

Cash flow is not the same as net income. One of the most common questions a CPA is asked is, “If I made so much money where is it?” A common time when business owners really grasp this concept that net income does not equal cash flow is when they file their income tax return owing a large sum of tax because they had a profitable year, yet they have to borrow money to pay the tax because the cash isn’t in the bank to pay these taxes.

There are primarily two accounting methods used to keep a business’ accounting records: accrual basis and cash basis. The accrual basis of accounting records revenue when earned and expenses when incurred. For example, if you invoice a big sale in July it will increase the revenue shown on your income statement for the month of July and increase your net income. However, you may not collect the money from this sale until September. Your financial statement shows additional net profit in July but this net profit is not represented by cash in the bank. It is basically a “paper” profit.

The cash basis of accounting recognizes income when cash is collected and expenses when paid. You might think that net profit and cash flow would equal using the cash basis of accounting. They could equal but they usually don’t.

If you want to learn the relationship between net income and cash flow, ask your CPA to prepare you a statement of cash flow and then make an appointment to discuss cash flow with him or her. If you are one of the business owners that actually believe the commercial that says if you use QuickBooks you don’t need an accountant, at least find and select the report menu and run the statement of cash flow. Unless you are an experienced bookkeeper or accountant yourself this statement of cash flow probably won’t be correct, but hey, you generally get what you pay for. The statement of cash flow provides important information about your business.

Let’s move from the theoretical to the practical. Many businesses in the River Valley are starting to feel the effects of our current down economy. This feeling of discomfort is usually directly related with negative cash flow. So how do you increase cash flow? The only way to increase cash flow in your business is to increase sales, cut costs, speed up collections, slow down paying your bills, borrow money or find an equity investor.

The most likely reason for your business’ decreasing cash flow in these economic times is less sales. For me to tell you to just go out and increase your sales when our economy is shrinking would be pointless. Almost everybody is trying to increase their sales. However, it may be time to re-evaluate your marketing plan and your product or service offerings. Try to be innovative. Necessity is the mother of invention.

• Manage your accounts receivable. With lower sales you may be tempted to sell to anybody but your cash flow won’t increase if you don’t get paid for the sale. Establish or review credit policies. Set credit limits to protect against bad debts. Ask to see your customers financial statements if the sale is substantial and you are concerned about their ability to pay. If they are reluctant to give you financial statements reconsider whether you should make the sale. If your gross profit on the sale was 20% and that sale became a bad debt, you would have to sell five times the amount written off just to cover the loss from the bad debt.

• Accelerate collection of your accounts receivable. If you are in a temporary cash crunch, ask your customers that owe you money if they can pay you early. Most people in business have been in your shoes before with their on cash flow problems. Generally they will help you if they can. You also might consider offering discounts for quick payment of accounts receivable.

• Become a bootstrapper. You have heard the saying “pull yourself up by your boot straps.” Bootstrapping is a term to describe how entrepreneurs without a lot of equity or borrowing ability have to operate their business. Bootstrapping might mean understaffing and working longer hours yourself. It might mean putting your kids to work since they are not in school this summer. Bootstrapping means becoming resourceful when you lack resources.

• Cut costs. When things are booming some business owners have a tendency to become lazy and not watch costs closely. Don’t overlook the small costs. They add up over time.

• If you owe a vendor and can’t pay them on time, call them. Many vendors will work with you as long as they believe you will eventually pay them. They want you as a customer. Arrange to make partial payments. Most vendors will not be insulted if you can’t pay your invoices on time unless you dodge their phone calls and won’t discuss your situation with them. Well, that’s not totally true. If you owe a local vendor money and they see you drive a more expensive car than they do or take expensive trips that they can’t afford, that upsets them. It upsets them because you are able to drive the expensive cars and take the big vacations by spending their money, the money you owe them. Don’t live big on your vendor’s money.

• You manage what you measure. Predict or forecast your cash flow for six to eight weeks into the future. The effort of forecasting your company’s cash flow will make you more aware of costs, which customers should be given priority, and when to call your banker. Your cash will flow more positively because you are measuring cash flow and are more focused on cash flow.

I will continue this discussion regarding cash flow pressures in two weeks when we look into the minds of commercial loan officers at our local banks. How would a commercial loan officer view you and your business if you applied for a loan?

David Potts is a certified public accountant also accredited in business valuation. Owner of Potts & Company, Certified Public Accountants for more than 25 years, his practice focuses on small and medium size businesses and their owners in the areas of taxation, accounting and bookkeeping, business valuation and business advisory services. He is a Fort Smith native and a graduate of the University of Arkansas at Fayetteville. You can follow more of his thoughts by reading his blog at ThePottsReport.com.