Manage Cash to Stop Bleeding Green

Manage Cash to Stop Bleeding Green

Business owners and their employees are the heart and soul of the business enterprise. They are the talent and personalities who deliver the goods and services and who connect with customers and the market.

However, the “blood” that runs through the “veins” of the business and that keeps the heart and soul alive is green. In other words, Cash is what keeps the business alive. Obviously, poor cash management can cause a crushing blow to the heart and soul.

When queried as to why the Income Statement shows a profit. But there is little or no cash available. Tax accountants generally state that Accounts Receivable Collection and Inventory-for-Resale are where cash shortages are generated. The observations are correct. But generally, if not always – tax accountants offer little guidance as to how to correct the conditions. So the following paragraphs are offered to help fill that void.

First and foremost, at all times the business owner must know where the money is. Cash coming in and cash going out must be managed and planned. The business owner needs to know instantly or within minutes how much money is in the checking account. How much the business is owed, and how much the business owes. Properly used accounting software can provide the business owner with the information needed.

Regrettably, most small and many medium-sized businesses do not manage cash very well. Business owners will invest in technology and tools. But will hire or retain under-trained talent to manage the accounting software and to take charge of company cash. Even worse, in the smaller of the small businesses, often the business owner controls the cash. It is not uncommon for business advisors to discover that the owner may not understand the difference between Cash-on-Hand (what’s in the check book). And Available Cash (how much cash remains after expenditures due are paid). Often the thinking is that if there is money in the checking account, it is available to spend. Cash on hand does not automatically equal cash available to spend.

Like any other operational function of a business, successful cash management begins with a plan.

A Thirteen Week Cash Management Plan works well for most businesses. The number of weeks could be less or even more depending on the business. But a Six Week Plan must be the minimum as only then can two different calendar months be represented in part each week.

Typically Cash Management Plans are prepared in the spreadsheet format that shows what, when, and how much is due at the start of each fiscal week for all categories and parts. Almost always, the spreadsheet format will contain an update function that adjusts entries on a weekly basis (e.g. Monday morning) on command by the operator. (Cash Management or Cash Flow spreadsheets are very common. So there are many sources available to business owners to acquire a model to use.)

A Cash Management Planner is a tool, rather than an accounting financial report. Consequently, the Cash Management tool must be separate from the Accounting software. As a tool rather than a report, the user has the option to make changes that the Accounting system may not accommodate or permit. (Many off-the-shelf accounting software programs now contain a Cash Flow feature, but most of them have limited functions. It is better to start with the style that is separate from the accounting software.)

There are three major parts in the Cash Management Planner. Routine Scheduled Expenditures or Payments with Due dates is one part. Accounts Payable Amounts and Due dates, and Accounts Receivable Amounts and Due dates are the other two parts.

The Routine Scheduled payments such as rent, utilities, telephone, lease payments, sales tax, and administrative payroll are easily identified. These scheduled payments can be weekly, bi-weekly, monthly, quarterly, semi-annually, annually. Or any other consistent and pre-set time period or date.

Small business owners tend to pay early and tend to wait long to get paid. Obviously this condition is not favorable to cash management. A balanced Accounts Payable and Accounts Receivable Aging (average days to pay or to get paid) is the desirable alternative. An unbalanced Aging condition is often the result of poor management. But the good news is that those unfavorable conditions can be remedied easily.

Accounts Payable is almost exclusively Direct Costs or Cost of Goods Sold. Accounts Payable is what the company owes to vendors and suppliers. Usually, paying vendors and suppliers early (before Net Due Date) is not a desirable practice. However, if an early pay generates a discount, then there may be merit to paying early. A frequently used payment term that offers an early pay discount seeks the full amount is due in 30 days. But offers a 2% discount when paid in 10 days.

Obviously a healthy or robust cash status will allow a business owner to take advantage of early pay discounts. Often the fiscal year savings are significant. To illustrate, if the business buys $2,000,000 of Inventory-for-Resale parts or products from a supplier who offers a 2% discount for early pay, then the business owner can save $40,000. The savings may be available for the business owner to use for purchases, improvements, added staff, or pay other expenses.

On the other hand, there are ways to take beneficial advantage of early pay discounts without a robust cash position by using the business Line of Credit (LOC).

If 6% is the interest rate on LOC funds used. Then the interest cost for use of LOC funds equals approximately 0.5% per each thirty days before repaying. When the business owner uses the LOC to capture the early pay discount on a vendor invoice. Then the 2% early discount is reduced by only 25% to offset the interest charge for 30 days use of LOC funds. But still realizing 1.5% savings on the vendor invoice.

When a vendor invoice with an early pay option is received. Payment of the net amount due could be scheduled for 40 days later on the Cash Management Planner. At day nine, the business could use LOC funds to pay the invoice and save 2%. The LOC borrowed amount plus interest is then posted on the Cash Management Planner to be paid within the next 30 days.

Many companies employ this AP strategy. There is no secret to making it work other than the discipline required to meet the payment deadlines.

Typically, an Accounts Receivable Collections Program and Strategy is the most immediate benefit to cash management. As stated previously, for reasons good or bad generally small business owners will pay early, but collect late. An Accounts Receivable Aging average of 45 days or more days may offset any Accounts Payable savings described previously. And An Accounts Receivable Aging average of 60 days or more will negatively affect or cripple cash availability.

An Accounts Receivable Collections program is required for effective Cash Management in any business. But particularly in small and medium-sized businesses. Business owners tend to be reluctant to ask for the money that is owed to them at the risk of offending a customer.

[My message to those who feel that way is that it is your money, it is rightfully owed to you, and it is business, not personal. Your business is neither a bank nor a charity. If you treat customers professionally and in a business-like manner, they will respect you.]

An effective Accounts Receivable Collections Program is not random or reactive phone calls to customers with past due invoices. But rather a formal plan that requires clearly established and executed strategies, policies and procedures to contact customers with past due invoices on a regular, systematic, routine, consistent, uniform, timely, and professional basis.

Additionally, an effective Accounts Receivable Collections Program will incorporate and encourage the use of Credit cards, ACH payments, Early Pay Discounts, routine scheduled pay programs. And any other options that makes sense.

Often, small businesses owners are reluctant to accept credit cards in payment for Accounts Receivable citing that the cost charged by the credit card provider is too high. Some credit cards have a high processing charge, but processing charges for bank cards usually are 2.5% or less. However, processing charges notwithstanding. When a customer pays by credit card, the Collections process ends for the invoice or invoices covered. The latter feature plus getting cash sooner should more than offset a small processing charge.

When planned and executed properly, Accounts Receivable Collections Programs work very well.

Lastly, businesses owners with Inventory-for-Resale have additional issues of great impact on cash.

Inventory-for-Resale products and parts are purchased with the expectation that those parts and products will be sold. Consequently, until sold, Inventory-for-Resale is really cash in another form on the shelf. Part of the problem is just that! Products and parts for resale on the shelf are not perceived as cash. It is cash, but just in another form.

Additionally, business owners who view Inventory-for-Resale that remains on the shelf for months or more as “paid for”, truly it is not “paid for”. Inventory-for-Resale is not paid for until it is sold. Yes, the vendor or supplier was paid for the purchase of the parts. But the parts were purchased with revenues generated from other parts or products.

To Illustrate: A part or product that costs $100 sells for $150. Each one of this part or product that is sold will contribute $50 to Gross Profit or the Margin. However each one of this part or product that remains on the shelf unsold represents a loss of $150 because the purchase price has not been recovered. And there has been no contribution to company Margin or Gross Profit. Plus, the supplier or vendor was paid using funds generated by sales of other parts or products. Slow moving Inventory-for-Resale is a drain on cash.

The bleeding can be stopped by implementing a routine, formal cash management planner. By designing and implementing an effective Accounts Receivable Collections program. By establishing and implementing an effective Accounts Payable strategy, and by managing the Inventory-for-Resale.

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