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If cash is King, cash flow is Queen of the business empire.

Every business needs cash to survive, even if in today's electronic world the cash is digital.

But cash does nothing. It sits there, earning 1-percent annual percentage yield if you're lucky.

What yields profits and a return on your investment is how hard that cash works. We can tell how hard our cash is working with a little planning and monitoring.

King Cash needs a budget

Cash flow is the power behind the throne, the Queen who controls King Cash. Without cash flow, cash just sits there.

The Queen's plan reveals when cash is going out to pay bills and when it's coming in from sales, and identifies how to keep cash moving when too much time lapses between those two events.

When planned expenses exceed revenues, the business needs to use savings. If there are no savings, then owners have to find a way to put more money into the business, either from their own pocket or by borrowing. Planning ahead allows you to build savings for that time when sales slow, and it helps avoid the expense of borrowing.

Monitor cash flow

Two of the most common places where cash flow can be tied up are accounts receivable (A/R) and inventory.

Simple ratio calculations can determine how quickly A/R is returning cash and how hard each dollar of inventory is working. Comparing ratios from month to month shows if overall performance is improving or getting worse.

Cash hides in accounts receivable

Accounts receivable might also be known as lending money to your customers and it's important to track the amount of time your customers are holding your money. Most financial systems will prepare a report called "Aging of Accounts" to show how much money your customers owe. Ideally all accounts would be paid in 30 days or less. Focus attention on any accounts that are more than 30 days old, calling customers to get them paid up or start terms. Those customers are sitting on your money.

Inventory is cash

Consider your inventory as cash sitting on the shelf. You sell $1 worth of inventory for $2, reinvest $1 in new inventory and apply the other toward operating costs and profit. The more times that $1 repeats or turns over, the harder it is working.

For example, if my inventory dollars repeat once each three months, then it is turning over four times per year, or $1 earned $4 dollars.

How often your inventory should turn will depend on your type of business, but everyone can seek to improve their turns by discounting and selling off slow moving items and replacing them with more popular items, reducing spoilage and shrinkage (the accountant's term for "loss to theft," which sounds better on a financial report), out the back door.

Buy only what you ordered and don't accept items the delivery salesman wants to unload on you.

Small improvements in inventory turnover can result in big cash savings and profits. Reducing inventory turnover time from three months to two-and-a-half months could yield about 25-percent increase in cash available from inventory.

Avoid the death spiral

As pointed out earlier, one result of poor cash flow is business owners end up borrowing money for working capital, thus paying more interest expenses, further reducing cash flow for the business.

This pattern--low cash leads to increased borrowing, increased interest, lower profits, lower retained earnings, higher liabilities, increased current liabilities and even lower cash flow--can quickly become a death spiral.

Early detection of poor cash flow enables business owners to take corrective action. Using a current ratio (solvency) or a quick ratio (liquidity) can provide early warning of looming cash problems. It is recommended to calculate the ratio once a month and compare the results to the prior month to see if the change is positive or negative.

Calculate the current ratio by dividing current assets by current liabilities. Read the results as X dollars of assets per dollar of debt.

While similar to the current ratio, a quick ratio measures only the cash available to pay current bills. Calculate the quick ratio by adding your cash to accounts receivable then dividing by current liabilities. Read the results as X dollars of cash per dollar of debt.

For both ratios results less than one is a warning of the lack of ability to pay your bills.

Jim Fletcher has been helping business owners improve business performance at the Wenatchee Small Business Development Center for more than nine years. His office is part of the Washington SBDC, locally supported by the Port of Chelan County and the Port of Douglas County in a cooperative effort of Washington State University and the US Small Business Administration. He can be reached at 509888-7252 or
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Title Annotation:BIZ BITZ
Author:Fletcher, Jim
Publication:Wenatchee Business Journal
Date:Sep 1, 2012
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