Cash isn’t king…it’s the ace

When your business was growing quickly, how did you generate cash flow?

For the past couple of decades, I’ve provided consulting chief financial officer services to a variety of businesses. Every successful entrepreneur I’ve worked with wanted to grow and focused on increasing revenues. “Gotta increase sales!” was their motto. Yet the only way for the business to survive and grow was to generate positive cash flow.

In fact, for any business wanting to grow, managing cash flow is critical to surviving and eventually thriving. Unlike profit, which is an accounting creation of revenues less expenses, cash flow is real. Cash comes into your business from your customers and bankers and flows out to your employees, suppliers, and back to the bankers. It’s that simple.

The key to managing cash flow is to accelerate the velocity of cash flowing into your business while slowing, if possible, the cash flowing out of your business. It’s also important to generate profits in your business. However, profits don’t pay the bills, cash does. Any high-growth, high-profit company can easily run out of cash, as many entrepreneurs have learned the hard way. That’s why cash isn’t king, it’s the ace. Cash is the fuel you need to run and grow your business.

With interest rates rising (although still much lower than the 23 per cent my family paid when they operated Clear Lake Lodge in the 1980s) and inflation upon us, managing cash flow is becoming even more important. The times of easy growth and cheap money are behind us. Now it’s time to get lean and mean so you can fund your own business growth.

Bankers will be happy to lend you money if you have a history of profit, a strong and healthy balance sheet, and have demonstrated good management skills. A healthy balance sheet shows lots of retained earnings. Most businesses would qualify for total debt of double their retained earnings. However, an aggressive tax minimization strategy—the worst strategy to grow your business—will reduce your retained earnings. That severely limits how much you can borrow to grow your business. If your accountant has been minimizing your taxes, they have not been supporting your growth, and it may be time for a new accountant.

Typically, banks will provide a margined operating line of credit against a percentage of your clean accounts receivable (less than 60 or 90 days old, depending on industry) and against current inventory.

The message there is that you should never have accounts receivable over 90 days. Either collect it or write it off. You can still collect it even though it’s off your books. From my work with supply chain experts, I’ve learned that every business has too much inventory. Companies, especially now, are cumulating “just in case” inventory. That’s a very expensive security blanket. Be careful how you measure inventory turnover. The easy method is dividing total inventory into cost of goods sold. That gives an average although irrelevant turnover figure because it does not look at individual inventory units where fluctuation in turnover is dramatic. Some units will be turning over quickly and lots not at all.

Looking at an average inventory turnover is useless when it comes to analyzing inventory. If you analyze inventory by sales of units, you’ll be surprised to see that likely 50 per cent of your inventory might only account for less than five per cent of your sales. Carrying that excessive inventory is costing your company lots of money for storage, recording, insurance, moving it around, and staffing. The experts recommend having access to inventory in your supply chain from your suppliers (who are valuable strategic partners), but not owning it or storing it.

Okay, we’ve addressed accounts receivable and inventory. Now let’s talk about accounts payable. Make arrangements with your suppliers for flexible payment terms and ask for prompt payment discounts. The line of credit from your friendly banker (who you should know on a first name basis) will help to make those payments, take the discounts, and improve your profits.

For any business, especially a growing one, a weekly or monthly cash flow forecast is critical. In fact, when cash is tight, I recommend using a daily Flash report that measures daily sales, production, and cash flow. When you measure and pay attention to key metrics every day, you can improve them in real time.

Despite interest rates rising, debt is still cheap. To preserve cash, don’t pay cash for long term assets like vehicles or equipment. It makes much more sense to borrow or lease for capital assets. In summary, befriend your banker as they really understand cash flow, train your customers to pay you more quickly, and borrow wisely to fund your profitable growth.

Remember, cash isn’t king, it’s the ace. How many aces are you holding?