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How Cash Flow Can Keep You Out of Trouble

by Brett Backues on September 14, 2015
Would it surprise you to know that a number of small and medium-sized enterprises (SMEs) are forced to close their doors every year simply due to poor cash flow? In fact, it doesn’t matter how strong your sales number are, or how much profit is generated on each sale, if your receivable collection times are too long, or your financing isn’t in order, then you could go bankrupt. This is ultimately why adopting proper cash flow accounting principles and maintaining a positive cash position are vitally important to you as a small business owner. So, what does this involve?

First, cash flow refers to the outflow and inflow of cash from your business. If you have more incoming cash from receivables collection than you have going out in the form of bill payments, then you have a positive flow of cash. Consequently, if you have more outflow of cash in the form of bill payments, and less cash coming into your business in the form of receivables collection, then you have a negative flow of cash.

Second, there is an inherent difference between cash and liquidity. For instance, while your equipment and machinery have value, and could conceivably be liquidated to give you cash, that doesn’t necessarily mean that you have a positive cash position or have a positive flow of cash. It merely implies that you have assets in your position that could be turned into cash at some point in time.

Third, your inventory of finished goods could also be liquidated at some point. However, while it costs you money to have that inventory, and that inventory could also be turned into cash, it isn’t an indicator of a positive flow of cash unless you sell that inventory to customers. In fact, even if you were forced to liquidate that inventory at a later date, it’s more than likely that you’ll have to discount it heavily in order to sell it. Ultimately, while you will receive cash for liquidating the inventory, the discount you used to accomplish that feat likely isn’t conducive to producing substantial profit on sales. Ultimately, your flow of capital is a measurement of how much is coming in and out of your business. A strong backlog of sales, coupled with a high number of outstanding receivables, is a positive sign as it indicates that you have a substantial enough flow of incoming capital to support your operations.

However, it’s important to understand the difference between cash flow and cash position. Whereas the first refers to the incoming and outgoing flow of cash from your business, a cash position refers to how much cash you have on hand at a specific period of time. Keeping the flow of capital high implies that you have the ability to meet future debt obligations. These obligations could refer to future payments and installments on revolving lines of credit, payments to small business loans and or bank loans, in addition to future payments towards equipment, machinery and rent. In essence, maintaining a positive flow of cash implies that you are able to cover your own debt obligations in addition to meeting your day-to-day operating expenses. Of course, maintaining this implies you have a substantial backlog of orders and sufficient sales to support your future debt obligations and daily expenses. While high sales volumes, and a healthy backlog, are needed to keep the flow of cash positive, that doesn’t necessarily mean that they are the only ways a company can maintain a positive cash position.

Remember, a positive cash position refers to your small business’s current cash on hand. This implies that you have more cash at a specific moment in time, which invariably means you are doing something to keep more cash in your business. So, what are some of the strategies you can employ to improve your cash position? Customers with Poor Credit Customers who are largely considered uncreditworthy can really help small businesses with respect to keeping more cash on hand. This is because there is no need to finance any receivables. The customers must pay upfront in order to receive their order. In this case, it’s similar to a point of sale (POS) transaction seen in consumer markets. However, in this particular case, the customer must prepay with cash in order to receive their order as opposed to putting their order on a credit card or paying from a line of credit. Uncreditworthy customers represent quick sales, an immediate infusion of capital and higher profit on transactions because your small business isn’t forced to finance their receivable. You get instant cash, long before any shipment is scheduled.

Leasing Equipment and Machinery Again, a positive cash position implies that you have more cash on hand at a given period of time. As such, it’s a good idea to lease large equipment and machinery as opposed to making an outright purchase. Leasing large capital expenditures keeps more cash on hand because you are leasing depreciating assets as opposed to buying appreciating assets. Leasing is an option that extends beyond large capital equipment. You can lease office supplies like laptops, smartphones and printers in addition to renting out office space and warehouse space. Any business-related tool you can lease instead of buy should help you keep more cash on hand. Offering Upfront Rebates and Discounts for Partial Prepayment Do not resign yourself to only pushing for prepayment from uncreditworthy customers. Instead, focus on a strategy where you use upfront discounts and inventory rebates in order to secure partial prepayment of a given customer order or total prepayment of the order. It’s really about giving your customer as many payment options as possible.

Negotiating Favorable Payment Terms If you can extend your payment terms to your vendors, without incurring any additional financing charges, then that will also help you keep more cash in your business for longer periods. On the opposite end, if you can negotiate a 1 percent or 2 percent discount for payment within 10 days of receiving an invoice, then that is another way to save money over the long-run. While this last strategy doesn’t necessarily improve your current cash position, it does provide savings for those periods when you aren’t as concerned about the inflow of capital. Alternative Financing Finally, there is always the option of pursuing alternative financing options like asset-based lending (ABL). These financing solutions allow you to use the liquidity within the assets you currently have in order to secure upfront capital. For instance, with receivables financing, you don’t have to wait for your customer to pay. Instead, you sell that receivable to a financing company who then advances up to 90 percent of the value of the outstanding amount. With purchase order financing, a financing company will advance you capital based on the value of your customer’s order or contract. In the end, these alternative financing options help to improve your current cash position by helping you avoid waiting for customer payments.  
Adopting proactive cash flow accounting approaches is ultimately about saving money and better managing the cash you have at this very moment. Each of these previously mentioned strategies can help you maintain a positive cash position, but the only way to improve the flow of capital into your business is to have a steady flow of incoming orders and a strong and robust backlog on sales.