Watch “Cash In”… Or Be Ready to Cash Out

by Bill Collier

Every business needs to ensure an adequate supply of cash. Run out of cash and it's over. Period.

Running your business by your checking account balance won't cut it. And since profit and cash are two very different things, your income statement is not much help either.

Many - if not most - expenses have to be paid before cash comes in from the sale. Cash may not be received from customers for 45 to 60 or more days after a sale has been made, but many cash outflows are immediate. For instance, try telling an employee that she'll get her paycheck in 60 days.

This is why businesses need an accurate and reliable way to monitor and predict cash inflows and outflows. One well-known approach is Working Capital:

WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES

Here are the main components of Current Assets:

• Cash
• Accounts Receivable
• Inventory

And these are the main components of Current Liabilities:

• Accounts Payable
• Current portion of long-term debt

While Working Capital is an important metric, there's no substitute for doing a cash flow forecast by projecting the next 12 months' cash inflows and outlays.
The way to do this: Set up a simple spreadsheet that starts with beginning cash balance. Each month, add cash in and subtract cash out to come up with an ending cash balance. This in turn becomes the beginning cash balance for the next month, and so on

You'll want to expand the "Cash in" and "Cash out" categories so you have more detail. For instance, cash comes in from receivables collection and from such sources as drawing from a bank line of credit. Cash goes out to vendors, payroll, paying down your credit line, etc. Use enough detail to paint an accurate picture of cash in and cash out.
Don't forget to take into account what portion of sales are on net terms and how long on average customers take to pay, how long you take to pay payables, how long inventory sits on the shelves, fixed asset purchases, and so on. Non-cash transactions (like depreciation) also need to be handled appropriately.
This approach requires you to estimate both sales and expenses going forward. Be conservative in your estimates! If you think sales will be $50,000 and you'll get paid in 35 days on average, you might consider using $45,000 for your sales estimate and 40 days for your receivables collection period. I'll say it again: Be conservative in your estimates!
So, what to do if you have a cash shortage? One tip: Don't wait until you're out of cash to deal with this possibility. Secure a bank line of credit before you need it.

Here are some general cash guidelines:
• Fund normal daily operations with operating cash flow
• Reinvest profits back into the business
• Fund growth with loans and/or equity

Yes, it requires work to do this. Many entrepreneurs would prefer a simple formula, like Working Capital. But a formula can't adjust for business seasonality and all the other inflows and outflows that come into play. Take the time to set up a cash forecast and use it every month to help you protect your most vital business asset.

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