In-Depth

A Steady Flow

When it comes to small-business cash flow management, it's wise to think -- and plan -- before you spend.

Managing cash flow is both the most simple and the most complex exercise in running a company. At first glance, the process seems painfully obvious: Invoice quickly, don't pay bills before they're due and make sure you've got enough cash in the bank to pay each month's expenses. Yet balancing all those tasks while running and trying to grow your business can pose a real challenge -- and doing the job well involves much more than simply keeping an eye on "bills in, bills out."

"Cash flow is at least as -- if not more -- critical than managing your profits," says Pete Heyler, a small-business and accounting expert based in Missoula, Mont. "You can survive with losses for a while, but not without cash."

Many small-business executives mistakenly believe that cash flow isn't an issue as long as growth and profits remain healthy. But growth actually produces a cash-flow drain, observes Heyler, an independent consultant, former CFO and co-author of Managing Cash Flow: An Operational Focus (John Wiley & Sons, 2002). Another common problem for small companies, especially young ones, is undercapitalization. "They don't have enough money to begin with, so they have to spend money before they get it," Heyler says. "It's a noble goal to get by with as little as possible, but sometimes you can cut yourself too thin."

Get It on Paper
Before you can think strategically about cash flow, you need to create a cash-flow plan (also called a budget or forecast) that tracks your monthly expenses and projected receivables. Your budget should also account for occasional and irregular expenses (see "Tools for Maintaining the Cash-Flow Pipeline" below).

To begin, get a handle on regular expenses. Mark LeBlanc, a La Jolla, Calif.-based consultant, advises business owners to break expenses into three categories: owners' compensation, business-development expenses (which includes sales and marketing staff salaries) and administrative/overhead costs. Doing this can help reveal which categories eat up the most cash and provide clues to achieving better savings in those areas.

For service businesses, staffing accounts for the bulk of expenses. An HR consultant can help you analyze whether your salary and benefits packages are competitive -- or actually over the top. In addition, business owners often pay themselves too little or too much and may need to adjust the ratios, says LeBlanc, who is also the author of Growing Your Business (Expert Publishing, 2003). In a small services firm, for instance, he advises that owners take 50 percent of gross profits as salary, putting 35 percent toward business development and 15 percent toward administrative and overhead costs.

If you're selling products as well, buying the items on consignment can have a positive impact on cash flow, according to Heyler. You'll have a lot more flexibility if you don't have to pay the supplier until the customer makes the purchase.

"Cash flow is at least as -- if not more -- critical than managing your profits. You can survive with losses for a while, but not without cash." -- Pete Heyler, Co-Author, Managing Cash Flow: An Operational Focus

Once you've got your cash flow plan in place, don't neglect it. Experts advise reviewing your expenses and income on a monthly, if not bi-weekly, basis. You don't need a fancy software package to accomplish that; Heyler uses a Microsoft Excel spreadsheet. LeBlanc, however, swears by small-business financial applications such as Microsoft Money or Intuit QuickBooks because they help with decision making. "Use it to evaluate your balance sheet, not just for looking at inflows and outflows," he advises.

Once you know what your average monthly spending entails, you can establish a "rainy-day fund" for those (inevitable) periods when business is slow or you lose a primary client. Three months' worth of savings is an ideal cushion, LeBlanc says, but one month of expenses in the bank is certainly better than nothing.

Tools for Maintaining the Cash-Flow Pipeline

Following are some simple steps for effectively managing your cash flow:

  • Be sure to budget for both regular and predictable expenses, such as quarterly taxes, employee bonuses, liability insurance and equipment purchases, upgrades and maintenance.
  • Only buy what your business really needs. Bulk purchasing works only if you actually use what you buy.
  • Pay vendors on time -- neither early nor late.
  • Treat your vendors like partners; in return, you’ll receive great service, excellent terms and possibly some flexibility if you need to request a little extra time to pay their bills.
  • Seek expert advice before making financial investments or capital improvements.
  • Be sure to spend an ade-quate amount on business development -- ideally, 35 percent of gross profits.
  • Remember: Growth is expensive. Don’t outgrow your cash reserves.

Tactics, Tactics
Solid banking relationships are certainly critical to becoming a cash-flow king or queen. Rule No. 1: If you need help from a bank, go before you are desperate. As Heyler puts it: "Banks don't like to loan to people who really need it." A better strategy, in his view: Think of banks as a way to grow your business, especially when unexpected opportunities arise, such as the chance to acquire needed equipment at a good price.

Another tactic involves planning ahead for landing the "big account," when your company will need to quickly ramp up staff and supplies to handle the wave of new business. Setting up a line of credit in advance of such opportunities is a smart move, says Eva Rosenberg, a long-time tax and small-business consultant based in Northridge, Calif.

What should you look for in a bank? Size doesn't matter, but make sure it's a well-established institution that, at a minimum, has FDIC insurance guaranteeing the solvency of your accounts up to $100,000 if the bank goes under, Heyler advises. Look for an organization that offers the level of personal service and attention that you need. And, if possible, establish a relationship with a financial advocate -- an individual bank officer who's genuinely interested in your business and wants to support you.

Payroll is another area worthy of cash-flow consideration. At least 60 percent of small businesses miscalculate their payroll taxes, Rosenberg says. That can mean nasty fines from the IRS, which the owner must pay even if the company goes out of business. She recommends hiring a payroll consultant to handle that task -- which can involve as little as $30 a month for three to five employees.

The most commonsense tactic is to simply stay on top of your billing. Send frequent invoices rather than letting amounts due add up. Smaller bills typically get paid faster, Rosenberg says.

Rosenberg's other billing tips include:

  • Ask your best clients for payment in advance.
  • Develop friendly relationships with your clients' accounts payable employees.
  • Find out about clients' payment methods before signing a contract, just in case the deal requires a purchase order or another process that might delay payment.
  • Before accepting work from a new client, make sure that whoever signs the contract actually has the authority to hire and pay you.
  • Consider charging a late fee -- for instance, 5 percent or 10 percent -- for payments that take longer than 45 days. State your policy clearly in your contracts.

If a client simply can't pay up and you don't want to deal with the headache of collections, you might consider barter: Request worthwhile products or services in lieu of payment.

Another option: Hire a "factor" -- that is, a person or company that handles the billing for you. Rosenberg says that a factor typically gives you 80 percent of the amount invoiced up front, and, after collecting from the client, pays you a final 10 percent. The upside: You get the bulk of the money owed right away, which gives you cash flexibility while allowing you to focus on clients and business development rather than on paperwork.

When Disaster Strikes
Cash-flow crises affect almost every business at some point. The best "ladder" for climbing out of a hole is a contingency plan, such as that rainy-day fund or pre-arranged line of credit. Beyond that, LeBlanc advises, be sure to build healthy relationships with many clients, rather than relying on just one or two.

In a pinch, you might be able to approach certain clients to request better terms or faster payment, he says. The same goes for vendors. In fact, that's a good reason for paying your suppliers on time and otherwise treating them according to the Golden Rule: You never know when you might need to approach them for flexibility on their bills.

Combine good cash-management practices with careful planning and a bit of luck, and chances are that you'll never have to resort to those last-ditch measures.