We discussed the #1 thing you should do to improve cash flow in a previous blog post  (which was to improve your bottom line profit) and plan to  discuss the income statement and what your business should focus on to improve the bottom line in future posts. For now, let’s stay with the cash flow theme and talk about the next thing you should do to improve cash flow – Manage the balance sheet.

To refresh your memory on how the Cash Flow Statement reads, take a look at my financial statements blog posting on The Cash Flow Statement. Remember, the top line on the report is Net Income – now you see why the #1 thing you should do to improve cash flow is to improve net income (profits) because that’s the ultimate source of cash flow!  The cash flow statement then begins to reflect how balance sheet line items affect cash flow.

So, let’s look at the balance sheet to make sure we are doing everything possible to manage assets and liabilities in the best way to have a positive impact on cash flow.

The following is a brief look at the “big three” line items that usually have the biggest impact on cash flow management for small businesses. Not all of these items apply to every business, so read accordingly. Also keep in mind the cash flow statement is analyzing a period of time, like last month, last quarter, or last year.

Accounts receivable – if there is an increase in the balance of accounts receivable, it is considered a use of cash. Why is this so? An increase in receivables means there has been an increase of sales that have not yet been collected.  It is a use of cash generated from sales. The opposite is true as well, a decrease receivables is a source of cash. What can be done to manage accounts receivable?

Here are a few short tips, keeping in mind an entire blog could be written on receivables management;

  1. Make sure all of your customers understand your payment terms up front. Even in the proposal stages make it clear what your payment expectations are, and repeat it often.
  2. Send a reminder note or courtesy phone call when any customer becomes even 1 day past due. It can be very friendly and courteous, as in “We just want to make sure you received our invoice. Have you been satisfied with the delivery of our product or service?”
  3. Management should be reviewing accounts receivable aging often, making sure you do not keep doing business with customers that are past due repeat offenders. Sometimes just letting a customer know that you are aware they are often past due will bring them in line with your expectations. In extreme cases require them to get current before doing any further business, and then make special COD arrangements.
  4. And of course, in order to execute 1, 2 and 3 you have to keep your receivables aging up to date and accurate. Seems elementary, but you would be surprised how many incomplete and inaccurate receivables aging we clean up as we bring on new clients.

Inventory – an increase in inventory levels is also a use of cash. Makes sense right?  It takes cash to buy more inventory than what was sold during the period being looked at. And if your inventory levels go down, you have generated more cash by using inventory already on hand to fulfill sales. The best thing you can do to manage inventory is to try to improve your inventory “turn”. Make sure your inventory turn is at least as good as an industry average for your business. If it is not, then that should be your goal.

Begin analyzing your inventory to see if there is any old or stale inventory that you can move out the door at deep discounts to get it off your hands – discounting this inventory is OK, it’s not generating any cash by continuing to sit on the shelves. Next, make a management decision that “just in case” inventory is not a good idea – let’s explain. You’ve heard of “just in time inventory” right – making arrangements with vendors to deliver inventory in a very short turnaround time so you can fulfill sales without keeping inventory on hand – a great idea and a great way to improve your inventory turn, but usually very difficult for a small business without huge buying clout to pull off. Well, the opposite for many small businesses is they carry “just in case” inventory – carrying inventory just in case some of our best customers might need it. We’ve seen this justification way too often for carrying very slow moving inventory – “we need to have it on hand so we don’t disappoint our best customers.”

Once you understand just how devastating that can be to cash flow perhaps you will change your mind. Ask you finance division to show you how much cash flow can be improved if you improve your inventory turn by just a half a turn, or even just a quarter of a turn. If you customers turn to you for the products that you are an expert in, chances are they won’t be too disappointed if it takes a little bit longer (because you no longer stock it) to fulfill an order for something they rarely ask for.

Accounts payable – as a liability on the balance sheet, if the balance in accounts payable increases over the period being analyzed it is considered a source of cash flow. This is so because it means you have incurred an expense or increase in an asset (inventory for example) for which you have not yet paid for. If accounts payable goes down it is a use of cash as you obviously had to use cash to pay off some of the payables to create the decrease over the period. Some tips for managing accounts payable;

  1. Negotiate extended payment terms when working with new vendors. It is much easier to ask for payment terms beyond the vendor’s usual policy when they are excited to land a new account. It’s pretty difficult for a small business to negotiate extended payment terms if you are already a customer of the vendor.
  2. As mentioned for receivables, keep your payables aging up to date and accurate so you always know who you owe, how much you owe them, and when they expect to be paid. The best way to do this is keep it updated daily!
  3. Get in the habit of a weekly bill payment routine. This will smooth out the cash outflow, keeps you current with your vendors, and helps you avoid any embarrassing notices from important vendors and/or COD surprises.

Once you have a handle on the above and have become familiar with how each works, it should easily flow into weekly short term cash flow planning. Weekly short term cash flow planning is something we insist on with all of our new clients. We usually work it into a weekly bill pay (see #3 under payables above) phone call, in which we review with the owner(s) their current cash position, cash needs today to meet bill payments, and expected cash inflows and outflows in the short term. We review upcoming fluctuations in cash outlays, such as payroll next week, swings in bill pay needs in the next few weeks,  term debt re-payments in the next few weeks, etc., and then expected short term cash inflows. If the owner is spending 20 to 30 minutes a week reviewing this information with us they are usually way ahead of their competitors as far as cash flow management. It can even make it easier to sleep at night knowing how much cash you’re going to need, when you will need it and where it’s going to come from. And just by having this information top of mind it can lead to some surprising improvements in operations efficiency.

There is more to cash flow management than the short term take we just covered. We will cover some of the other action items in future blogs, but you can also ask your finance team about them – such as do we have the appropriate financing in place, using short term financing to finance short term assets and long term financing to finance long term assets. And while you’re at it, ask your finance department to help you understand just how much of an impact some of this cash flow management can really have. What happens to cash over the course of a year when you improve your inventory turn by a quarter turn, or receivables aging by just a few days?

Thanks for reading. Hope it helps you get a handle on your cash flow. We do it every day with our clients, and I know they sleep better at night because of it.