I am often asked by business owners how it is their business shows an annual profit, yet they have been short on cash throughout the year, are still struggling, and even have to put personal funds into the business to keep it open.
Profit and cash flow are two very different things, so there are a variety of issues that could cause these two numbers to differ significantly, often to the detriment of the business’s cash position.
Sometimes the problem is poor inventory management. It is critical that you keep proper records and carefully monitor inventory levels to avoid having too much cash tied up in inventory.
You should understand typical inventory turnover rates for your industry so you know how quickly the inventory should be moving. Know how your customers will respond to changes in price, so you can move inventory out quickly if needed.
You could be purchasing the wrong kind of inventory. Research and understand what your customers really want before you purchase. Carefully plan your purchases, taking into consideration customer preferences, seasonal changes and pricing.
If you have obsolete inventory, you should be willing to discount it significantly in order to move it, thereby bringing in cash and opening up room for the right inventory.
You may have too much cash tied up in accounts receivable. If you offer financing to your customers, develop and enforce credit policies. Policies that are too lenient or not enforced usually lead to an unacceptably high accounts receivable level.
Consider offering discounts for early payment. For example, if the term is 30 days, offering a 2% discount on payments received within 10 days can bring cash in sooner.
It is vital to bill promptly and monitor accounts receivable. Know which customers are not paying on time and how far behind they have become. Have a credit limit policy and an established process for following up on late accounts.
Your first step may be sending a friendly reminder letter. Then you could progress to more specific requests that discuss late fees and finance charges. Learn how collection agencies can help and when they should be used. Become familiar with small claims-court procedures.
Consider that it may not be necessary to have accounts receivable. Do you really have to offer financing to achieve desired sales? Is your competition offering financing? Could you use an outside finance company to handle those customers seeking financing?
Take a close look at how quickly you are paying your bills. If you have trade credit that allows you 30 days to pay, you may need to take advantage of that to keep cash in the business. But be sure your payment is not late. If there are discounts available for paying early, know what savings you are giving up if you just wait and pay on time.
You may be having cash problems because you are not using debt properly. While you must be careful concerning the amount of debt you take on, you should not allow your operating cash to run low because you purchased long-term assets with cash. Be willing to take on some debt as necessary to protect your cash reserve so that you will be prepared for unforeseen cash needs.
When you do take on debt, obtain the proper type of debt for the planned use. Do not buy long term assets using short term debt. Also be sure to create financial projections to look at the effect of the proposed debt on your business.
Finally, if you are not developing monthly (sometimes even weekly) cash flow projections and regularly updating them, you can easily run into cash flow problems. Understanding your business’s cash flow and planning for potential shortfalls can be the difference between staying open and having to shut your doors.
The University of Georgia Small Business Development Center (SBDC) provides free assistance with analyzing and managing your business’s cash flow. Contact your local SBDC for more information.
Connie Edwards is Business Consultant for the University of Georgia Small Business Development Center in Savannah. Contact her at 912-651-3200.