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Most businesses fail because of cash flow - Understand it!

Written by: Joe Dager

Article Overview: To be competitive, small business owners must plan and prepare for all future events and market changes. Possibly the most important aspect of preparation is effective cash-flow planning. Failure to properly plan cash flow is one of the leading causes for small business failures in the United States.

Most businesses fail because of cash flow - Understand it!

To be competitive, small business owners must plan and prepare for all future events and market changes. Possibly the most important aspect of preparation is effective cash-flow planning. Failure to properly plan cash flow is one of the leading causes for small business failures in the United States. Experience has shown that many small business owners lack a general understanding of accounting principles. For this reason, a few of the basic principles will be covered. There also are self-instructional guides from which you can obtain a better understanding of accounting. The Basics: Cash in business serves several purposes. First, it is used for meeting normal cash obligations (i.e., paying bills). Second, it is held as a

precautionary measure for unanticipated problems. Third, it is held for potential investment purposes. The term "cash" refers to: Cash, Checks, Checking Accounts.

The Operating Cycle: The operating cycle can be defined as the system through which cash flows, from the purchase of inventory through the collection of accounts receivable. It measures the flow of assets into cash and is, in effect, a "business stopwatch." For example, the operating cycle may begin with both cash and inventory on hand. Additional inventory is purchased on account to work as a cushion for future sales to guarantee that you will not deplete your stock. Except for cash sales, when some of your inventory is sold, accounts receivable increase, but your cash doesn't. Typically, you pay for the inventory you have purchased thirty days after it is received. When the payment for inventory is made, both cash and accounts payable are reduced. Thirty days after the sale of inventory, receivables are usually collected, which increases cash. Now your cash has completed its flow through the operating cycle and is ready to begin again.

Current Assets: Cash and other balance sheet items which convert into cash within twelve months are referred to as current assets. Typical current assets are: Cash, Marketable Securities, Receivables, Pre-Paid Expenses.

A Plan is Necessary: Cash-flow analysis shows whether your daily operations have generated enough cash to meet your obligations, and it shows how major outflows relate to major inflows. As a result, you can tell if inflows and outflows from your operation combine to result in a positive cash-flow from operations or in a net drain. Any significant changes over time will also appear. Understanding this will lead to better control of cash-flows and will allow adequate time to plan and prepare for the growth of your business. It is best to have enough cash on hand each month to pay the cash obligations of the following month. A monthly cash-flow projection helps to project funds and compare actual figures to past months. It is important to project your monthly cash-flow to identify and eliminate deficiencies or surpluses in cash. When cash-flow deficiencies are found, business financial plans must be altered to provide more cash. When excess cash is revealed, it might indicate excessive borrowing or idle money that could be invested. The objective is to develop a plan which will provide a well-balanced cash flow.

Planning a Positive Cash Flow: To achieve a positive cash flow, you must have a sound plan. Cash reserves can be increased by: Collection of receivables, Tightened credit requirements, Price of products, Loans, Increased sales, Collection of Receivables.

Actively manage accounts receivable and quickly collect overdue accounts. Revenues are lost when a firm's collection policies are not aggressive. The longer your customer's balance remains unpaid, the less likely it is that you will receive full payment. Tightened Credit Requirements, as credit and terms are tightened, more customers must pay cash for their purchases, thereby increasing the cash on hand and reducing the bad debt expense. While tightening credit is helpful in the short run, it may not be advantageous in the long run. Looser credit allows more customers the opportunity to purchase your products or services.

But, be certain that the increase in sales is greater than the increase in bad-debt expenses. Pricing of Products, The primary goal of business is to make a profit. Many small businesses fail to do so because they do not know how to price their products or services. Pricing is the critical element in achieving a profit as well as in maintaining positive cash flow, and is a factor all firms can control. Before setting your prices, you must understand your product's market, distribution costs, and competition. Remember, the marketplace responds rapidly to technological advances and international competition. You must keep abreast of the factors that affect pricing and be ready to adjust. Loans, Loans from various financial institutions are often necessary for covering short-term cash-flow problems. Revolving credit lines and equity loans are common types of credit used in this situation. Increased Sales, Increased sales would appear to increase cash flow, but be careful.

For many companies, a large portion of sales are purchased on credit. Therefore, when sales increase, accounts receivable increases, not cash. Collection of receivables is usually 30 days after the purchase date, and sales expenses are most often incurred befor e receivables are collected. When sales rise, inventory is depleted and must be replaced. Because receivables have not yet been collected, a substantial increase in sales can quickly deplete a firm's cash reserves. Again, by using a computer, you can maintain this critical data, as well as speed the time required to consider the "what if" concept.

Other Helpful Tips: Cash Reserve, You should always keep enough cash, as an added cushion for security, on hand to cover expenses. But, it is unwise to keep more money on hand than is necessary to cover your obligations. Excess cash should be invested in an accessible, interest bearing, low-risk account, such as a savings account, short-term CD or T-bill. Keeping excess cash on hand reduces both the growth and the return on investment. Projections, Good accounting records and projections are important tools for a small business. Qualified accountants are necessary to help keep your records accurate and current. However, you can reduce your accounting expenses by producing your own summary statistics and projections.

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Article Tags: business failures, future events, market changes, small business owners



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Tax returns! - Well, this is new on me. i had no idea you could sell a site off. If it's anything like purchasing a non-internet business then you need to check into multiple things. Will you need to finance to purchase? If so, you'll need to calculate the cash flow. Also, find out if there will be any add backs to the cash flow, for example, are there other workers invovled to keep the site running...perhaps workers you won't need when you take the site over? Their salaries can be added back to the cash flow if you will not need them. You must see the top page of the last year tax return (never go off just the P & L's). Did the seller run anything personal thru the tax returns that you wont? That's also considered an add back to the cash flow. What is the gross sales for the 12 months? What is the net income for the 12 months? Make sure the purchase price is justified. You can calculate a ball park range on this by doing 30 - 50% of the gross sales for the year or 3- 5 times the net earnings. What is the web traffic like? Is it steady? Do you have time to run the site or will you need to hire someone to manage it? Make sure the business is supporting itself and is profitable. Does the seller have an initial business plan from when they bagan the business, so you can look it over?
Take the money! - Or rather - accept the investment! [quote:3iervw6d] but I'd prefer to only "take the plunge" and potentially lose my own money rather than his as well. [/quote:3iervw6d] Seems to me that this is what angel investors are needed for. If you have a good business plan, and if you think your shop willl work, why not let your friend invest in it? If there's a chance of it failing...[i:3iervw6d]you [/i:3iervw6d]shouldn't be starting it to begin with. As I'm sure you know, most businesses fail because of a lack of cash flow in the early years. Explain to your friend about this, show him all the books, and if he still wants to go ahead...let him!
Re: Improving Cash Flow - Hi aquinm78, Those are 10 excellent tips you shared for businesses to reduce debt and increase cash flow. Thanks for the detailed post as I'm sure many of us can put these to good use for both our business and personal lives. Take Care, Alan
Re: Interrealtionship between financial statements - Yes, it’s necessary to take a complete toll of account transactions. If you don’t, then how would you be able to track your financial figures? For example, If a person sold goods for USD 5,000.00, half in cash and half in credit, then with taken impact of all three i.e. cash flow by USD 2,500.00 balance sheet through both cash and receivable and income/P&L statement by USD 5,0000.00, the transaction will not be complete.
Improve your Cash Flow - As we all know, the primary concern of proprietors and managers are cash flows. I would like to share some tips on how to improve the cash flow of your business. 1. Speeding up Collections - collecting receivables earlier, on or before due dates. Discounts for early payments can be one way to do this. 2. Slowing Down Payments - stretch your payables and pay only when it is due. But be careful not to mess up with your credibility. 3. Invest in Marketable Securities - use the money in Marketable Securities and other short-term investments to earn extra cash.


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