The cliché is that Cash is king. In this case, the cliché is correct. I am fond of saying that in the short-term, a business owner should be most concerned with cash. In the medium-term, the main concern should be profitability. And in the long-term, the owner should concentrate on building the value of the business.
Business owners are often confused by the distinction between cash and profit. Profit is good, even wonderful. In fact, profitability in a business isn’t a panacea but it is darn close. But there are times when a profitable business, especially during periods of fast growth, can’t fund payroll or suppliers. The trick is to keep the employees and suppliers paid until receivables can be collected. But sometimes, the timing is such that it can’t be done. This can cause a profitable business to fail.
Profit is the difference between revenue (when earned) and expenses (when incurred). Cash flow is the difference between cash inflows and cash outflows. Profits and cash flow can be very different in terms of their timing.
This article is about the thing that is to a business as blood is to our bodies. Cash.
The Seven Rules of Cash
Rule 1: Cash is King. If you can’t make payroll, all the profitability in the world isn’t going to keep your business alive. Cash also provides options. You can take advantage of opportunities that otherwise are missed.
Rule 2: Know Your Cash Balance at All Times. The business owner should know how much cash they have in their accounts, within reason, at all times. Plus, they should know what the balance on their line of credit, if they have one.
Rule 3: Keep track of Cash in your Accounting System. Often I see accountants who keep a side ledger for keeping track of Cash. This is a poor practice. If transactions are recorded when they are made, there is no need for a parallel system. Plus, with a parallel system, if there is a discrepancy, you’re always reconciling the two systems. It’s a big waste of time.
Rule 4: Don’t Manage from the Bank Balance. I am always amused when bank tellers ask if I want my balance. I know my balance better than you do! Your book balance includes items in transit and checks that haven’t cleared yet. Your book balance is the cash balance, not what the bank shows.
Rule 5: Know Your Cash Balance Six Months from Now. Can you predict what your cash balance will be six months from now? If not, you’re reacting. You need to have a plan for your business including a budget and cash flow projections. Speaking of…
Rule 6: You Must Have Cash Flow Projections. You must be able to project your cash flow to be able to properly manage your business. If cash flows aren’t too much different from your accrual budgets, then the budgets will suffice. But if there are major differences, such as capital expenditures or long delays in receivable collections, then a cash flow projection needs to be done to predict your cash position into the future. The frequency of cash flow projections depends on how tight cash is. I’ve seen quarterly projections for companies with good cash flows. Monthly projections are typical. Weekly projections are done when things get tight. And, yes, I’ve done daily cash projections. Sometimes morning and afternoon.
Rule 7: Eliminate Cash Flow Worries and Spend Your Time on More Important Things. By managing your cash effectively, you can reduce the time you worry about it and spend less time making projections. And a line of credit can be very helpful in providing some flexibility in cash management. Once you are spending less time managing or worrying about cash, you can focus on growing sales, improving profit and working on things that add long-term value to your business. You’ll also sleep better at night.
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