Small Business Tip of the Week: Cash in, cash out
March 23, 2011 at 8:01 p.m.
Updated March 22, 2011 at 10:23 p.m.
Ever wonder why there is not enough cash in the drawer?
Small business owners reflect on this position every time they pay the bills, realizing that managing cash can be as complicated as managing people.
Despite what your Profit and Loss statement says, your cash is usually not as healthy. Understanding this difference begins with identifying where the cash is going. Uses of cash can be lumped into one of three categories: current liabilities, inventory and customer credit, and too much of either reduces the cash in the drawer.
Current liabilities are a mix of short-term debts and accounts payable - short-term debt for those expenses that take longer than a sales cycle, but less than an annual cycle to be repaid, and accounts payable for frequently purchased goods and services no yet paid for.
Depending on your production and delivery cycle, receipts can be slower than expenses and a credit line is needed to float you until you collect enough cash to repay the line.
Management of accounts payable is a little trickier. It's a push to extend payables as far as creditors will allow, and collect cash as quickly as you can. How does failing to manage either result in less cash?
When a project has a longer life expectancy than one year, the use of short-term debt can cost more and put a strain on cash flow. Not planning for cash needs during the operation of your business where sales and collection cycles fail to meet cash needs leaves you needing cash when it costs you the most. In too many situations, that means credit cards.
Finally, inefficient use of assets and resources requires more cash to do less. Every activity and expense must lead to value on the bottom line, and a review of these can quickly tell if you are maximizing that return.
Inventory is the greatest risk to cash. Not enough and you miss sales; too much and you miss cash; don't secure it and it disappears; keep it too long and it's worth less. Whether durable or perishable, inventory requires constant attention.
When is too much too much? Each industry determines a standard for inventory to turn. Too much is too much when its takes you longer to sell it than the industry standard.
Customer credit may seem like a good idea. It generates sales, gets your product in the market place, and creates relationships with your customers. The concept is as old as time itself, but the benefit is not as durable. Customer credit in itself is a great business practice, but it's to whom, for how long and how much that makes it lethal.
So where does this downside materialize? It prolongs the sales cycle tying up cash, the cost of this credit is rarely reflected in the sales price and it assumes unnecessary risk because it becomes discountable inventory on someone else's shelf until you collect.
Too much is too much when the cost of the credit you extend can't support a healthy return on your investment in the credit you receive. It's all about the "return."
Still wonder why there is not enough cash in the drawer? Let the SBDC team help you review these and other factors that may hold your business back. Call us for help any time.
Joe Harper is director of the University of Houston-Victoria Small Business Development Center.