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Better Business Idea #41

Some Thoughts About Cash Management

© 2000 by Michael C. Gray

September 30, 2000


Cash is the life blood of a business. Without sufficient cash, a business will be unable to pay the wages of it's employees, buy the fixed assets required to operate a business, pay for product development or pay for advertising and promotion to attract new customers and build a customer list. If the management of a business doesn't manage cash properly, they are setting themselves up for emotional distress and the business may not survive.

A fundamental planning document for a business is a cash plan. Ideally, the cash plan is for at least a twelve-month period, rolling forward monthly. The cash plan could incorporate the "budget" for the business. Questions to be addressed in the cash plan include

  1. What are the expected payments that will be required, and when will they be made?
  2. Where will the funds come from to make those payments and how will those funds be generated?
  3. Should the planned expenses be adjusted for the activities required to generate the cash or to eliminate wasteful expenditures?

Planning expected payments.

When planning expected payments consider that, for a given level of activity, a business will have a certain level of "fixed costs." Some people think of this as the monthly "nut" they have to make before they have excess cash. Of course some expenses happen periodically, like insurance payments or tax payments. Ideally, the business should discipline itself to have "side funds" or &"monthly reserves" set up for any of these expenses that are significant.

New businesses may run losses for a period of time as they establish their customer base. The management team must decide in the formation process what the cash requirements will be before the business will generate cash, whether they can finance the investment required and when to "pull the plug" because the business isn't performing as expected.

When a new business is able to raise a substantial capital base, it's tempting the "raid the fund" wastefully. We have seen this with some of the "Dot Com" companies that are now going out of business. Huge amounts were spent on various activities, including some ineffective advertising, that didn't generate enough income for survival.

Sometimes it can be better to build a business on a shoestring "because you have to." Starting a business on a shoestring requires using more creativity to invest funds wisely for maximum return.

Where will the funds come from?

There are three primary ways to generate cash - sales, capital investment, and debt. Sales is the only one that doesn't have "strings" attached, besides delivering the product or services. Investors expect to receive dividends or an increase in the value of their investment. Debt has to be repaid, usually plus interest. Interest can be a substantial fixed cost. (It's one of the biggest items in our U.S. government budget.)

Sometimes you can satisfy short-term financing needs by adjusting terms. For example, service businesses may require a deposit or retainer to accelerate cash flow. When your initial offer is for installment payments, you may be able to "upsell" customers to accelerate payment with a premium or a discount. You also might be able to negotiate with vendors to extend the time of payment with no penalty.

Adjusting for required activities and eliminating wasteful expenses.

When you decide how the funds are going to be raised, you may need to plan on additional expenses relating to the activities required. For example, if you will have a promotion to increase sales, you may need to plan for related advertising expenses and additional temporary employees to serve customers. You may also need to plan for buying or manufacturing additional inventory to sell.

When searching for wasteful expenses to eliminate, relate the expenses to the activities they relate to. "Across the board" cuts can also cut the heart out of the business. Perhaps some functions can be combined or automated through a reengineering study. Can you reduce fixed expenses by encouraging telecommuting? What would be the effect on employee productivity? Maybe you can try it on a test basis? Is your advertising effective? How do you know?

Evaluating cash investment alternatives.

Having a capital base of cash can, in itself, generate income through investment. When evaluating cash plans, you should compare the income you can generate through business activity with the income you can generate with investment activity. If you can generate more with investment activity with less risk, you should liquidate the business and invest instead or get into a more profitable business.

Remember one of the purposes of the business is to generate cash flow for the business owners and their families. The owners shouldn't have to continuously pour money in that they may never recover. The viability of the business must be evaluated from time to time based on how it is actually performing and whether the expectations of future improved performance are realistic in light of the facts.

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Why you should have a cash plan for your business.


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Michael Gray, CPA
2190 Stokes St., Suite 102
San Jose, California 95128
(408) 918-3162
Fax (408) 998-2766
email: info@profitadvisors.com
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