The necessity of a strong cash flow is irrefutable. You’ve likely read stories about companies that could post a profit but floundered anyway because they simply didn’t have the money on hand to move forward.
So how do you avoid this cruel fate? Well, cash helps. But, seriously, there are several essential elements that either inform or inhibit the ability of a business to steer clear of cash flow slowdowns.
Respecting the cycles
The success of virtually any company depends on two cycles. The first is the sales cycle — that is, how long it takes your business to: Develop, purchase or otherwise acquire a product or service, market that product or service, and eventually close a sale and collect the accounts receivable.
Indeed, collections — from clear, accurate invoicing to the use of bank lockboxes to speed access to money — is a major aspect of cash flow management.
Many companies either underestimate the impact of the selling cycle or lose sight of its gradual expansion. The former problem often affects startups: Entrepreneurs simply believe they can get their wares to market and close and collect on deals much more quickly than reality allows.
The latter quandary, losing sight of the elongation of the sales cycle, can affect even well-established companies. Regular customers may start taking longer to pay, or you might lose a major buyer and take much longer than expected to replace it.
The second cycle is the disbursements cycle. This is the process of managing the regular, outgoing payments to employees, vendors, creditors (including short- and long-term financing) and other parties. As payments go out, your cash flow is obviously affected.
The selling and disbursements cycles aren’t separate functions; they overlap. If they don’t do so evenly, your cash flow can slow to the point of crisis. For this reason, it’s critical for business owners to strive to adhere to the “matching principle.”
That is, just as you work to match revenue to expenses, you’ve got to ensure that your selling cycle (cash inflows, including outside financing) at least matches your disbursements cycle (cash outflows). Ideally, of course, you’re converting sales to cash more quickly than you’re paying out expenditures — thereby strengthening cash flow.
Accounting for your system
As your selling and disbursement cycles roll along, your company is generating data. Failing to process this information completely and accurately could lead to cash flow confusion … or worse.
That’s why, if you’re not leveraging the power of today’s financial software, you’re leaving yourself vulnerable to the whims of fortune. At the very least, your accounting system should allow you to enter common transactions such as logging cash receipts onto deposit slips, cash disbursements onto checks, and purchase and sales transactions onto orders and invoices.
From there, review your use and need for ledgers. Every basic accounting system has a general ledger, but you may need to upgrade to one with multiple subsidiary ledgers and special journals that simultaneously post when documents are saved.
Report generators are also critical for managing cash flow accurately. Your system should allow you to readily generate accounting reports — daily, weekly, monthly and annually. This means being able to easily record and access recurring transactions as well as aging of accounts payable and scheduling of payments.
Today’s accounting systems can also provide you with a “dashboard” of real-time information, so you’re less likely to be caught off guard by something that could affect your cash flow. In addition, budgeting tools can help you set and monitor budgets, perform “what if?” analyses and compare actual results to goals.
Making a statement
The data gathered and generated by your accounting system eventually needs to end up in your financial statements. These documents represent a powerful, “big picture” strategic tool.
Some startups and very small businesses tend to undervalue financial statements. A small percentage of companies don’t even keep them. This is a big mistake when it comes to managing cash flow. Your financial statements are essentially your last line of defense, with the selling and disbursement cycles being the front lines and your accounting system the command and control center.
Generally, financial statements contain three separate sections: 1) the balance sheet, which details assets, liabilities, and capital at a particular point in time, 2) the income statement, which provides operating results for a specific period, and 3) the cash flow statement, which reports the net increase or decrease in cash (again, for a specified time frame).
For the purposes of this discussion, the cash flow statement is obviously germane. Yours should factor in the cash inflows and outflows of daily business operations, as well as asset purchases, sales proceeds and financing activities. Because it excludes noncash accounting items, you can use it to pinpoint cash flow problems.
So the question becomes: Are you using it? Make this a regular topic of management-level meetings. If you want to get the most from your cash flow statement, you’re likely best off generating one monthly. But quarterly and annual statements can still be useful for identifying cash flow trends. (And for a recent development regarding financial statements, see the sidebar “Should you read the Guide?”)
Mitigating the tough times
Cash flow may seem capricious. But there are ways to anticipate slowdowns in workable dollars and mitigate these tough times. It all begins with regulating inflows and outflows, tracking the resulting data and reporting your company’s finances completely.
Holbrook & Manter, CPAs works with business of all types and sizes. We would be honored to work with you as well. Please contact us today.