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10 Cash Flow Truths - Part 1

Apr 11, 2024

Cash management is one of the most important jobs in a small business.

Today we talk about 10 cash flow rules and what they mean for your business.

But first, our sponsor.


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Cash management is one of the key factors in business success or failure, but something that’s often overlooked by new business owners.

Other the course of this newsletter, I’ve written a lot about cash but I’ve never really zoomed out and talked holistically.

So, today is that day.

As I went through all my resources on cash management, a number of themes kept coming up. And as I prepared this, those themes were present in all sorts of businesses at all sorts of stages.

So, I wrote down 10 cash flow truths that each and every business needs to abide by and understand intimately. Because 10 is a lot, I’m going to split this into two weeks. This week I’ll address the first 5 and next week I’ll address the next 5.

So, without further todo, 5 cash flow truths to understand:

Profits aren’t cash

Every business talks about revenue and profits, but profits aren’t cash. Especially if you’re running accrual basis financials, profits can be a world of their own.

The problem is, good profits can lull you to sleep and make you think you’re doing fine, but cash can tell a completely different story.

Not getting paid by customers? You have a cash problem.

Growing too quickly? You have a cash problem.

Businesses with payment problems and growth problems can be hell to run, even with healthy profits.

The best way to manage your cash is through 2 numbers:

  1. Operating Cash Flow
  2. Free Cash Flow

The goal with each number is to have positive operating and free cash flow over a longer time horizon.

If your operating cash flow or free cash flow is negative, that means you’re using cash from other areas:

  1. Previous cash balance
  2. Generating cash from financing activities
  3. Generating cash from investing activities

The Statement of Cash Flows is an underutilized statement that does a great job of showing how cash was used in a business.

Cash reserves are your lifeline

I get asked quite often how much money a business should keep as a balance and my regular answer is it depends. There are a ton of variables that go into how much cash you should keep on hand.

A few things to consider:

  1. Seasonality
  2. Payroll expense
  3. Customer Concentrations/risk
  4. Equipment or other asset needs

For businesses that have volatility or a lot of overhead, it’s important to be more conservative.

For businesses that can be more nimble, less cash may be needed.

A simple rule to follow is to look at the following:

  1. Average 3-6 month payroll cost
  2. Cash burn during slow months
  3. Cost of new equipment if broken down

Comparing these 3 numbers will get you a range of cash needs. The goal is two parts: sustain operations during a regular business downturn and give yourself time to make wise decisions during a catastrophic downturn (like COVID).

The right answer could be different based on the owner's financial profile (do you have other assets kicking off cash or large cash reserves?), which means that every situation is completely unique.

First and foremost: do what makes you comfortable and doesn’t create undo stress.

Cash reserves are the key to business health. Not having them means a good business can run out of money or have to make less-than-ideal decisions because of a cash crunch.

Your bank balance doesn’t reflect your obligations

I’ve talked about this a lot in this newsletter, but I will continue to talk about it: your bank account is a bad proxy for cash flow. All it tells you is what has hit your account at that moment. What it doesn’t tell you is:

  1. Checks you’ve cut yet not seen the cash come out
  2. Obligations you’ve made and know about

Instead of looking at your bank balance, create weekly reporting that reflects:

  1. Bank Trial Balance (accounting balance that includes already cut checks)
  2. Accounts Receivable Balance & Aging
  3. Accounts Payable Balance & Aging

This simple report gives you a snapshot of your current balance, expected money coming in, and recorded obligations. They’re only as good as the data in the system, so you have to keep that in mind. I like to make sure all commitments made are recorded as a payable so we can accurately know what’s coming due.

If you’re in a startup or tight cash position, a 13-week cash flow forecast may be necessary. 13 weeks allows you to see the “boogie man” coming and act today based on future obligations. It also gives you a more intimate relationship with your cash flow.

Anyone I’ve implemented this with has been blown away by what they learn about their numbers.

Software like NetSuite makes this easier, as you their built-in reporting tools allow you to build custom reports and get them delivered to the right parties with ease.

Thanks NetSuite for sponsoring this issue.

NetSuite is the #1 Cloud ERP that gives you complete visibility and control over your business operations, including financials, inventory, HR, CRM and more. Over 37,000 organizations have turned to NetSuite to help grow their top and bottom lines.

Click here to see what the future holds for AI and Machine Learning in finance.

Invoicing quickly increases your chance to get paid

Invoicing on a regular schedule sounds simple but often isn’t. It requires the whole team to be on the same page and working in concert together.

The reality is, changing your invoicing can change the way everyone in the company works.

But invoicing slowly, or inaccurately, means your customers will pay more slowly as well. Invoicing as soon as work is complete increases the likelihood that it’s fresh on the customers mind and that they will approve it quickly.

I’ve seen it time and again: you take 3 weeks to invoice and the customer sees the email come through, but they can’t remember was it 10 units or 12? So they think “I’ll come back to this later.” That “I’ll come back to this later” turns into weeks and it completely drops off their radar. Now their AP is involved and they don’t know either.

This brings up another problem: once you’ve invoiced you can’t “forget about it.” You need to actively manage outstanding receivables. I suggest:

  1. a regular schedule for sending out statements
  2. following up at over 30/60/90 milestones
  3. a documented process

It’s always best to have one person in accounting assigned to this process, if possible. They’ll develop a deep understanding of each customer and be able to see the warning signs earlier.

Being proactive with receivables makes it way more likely you’ll get paid.

I have 3 rules when it comes to invoicing and receivables:

  1. If you can collect money up front or at the time of sale, do it. It will add years to your life.
  2. Invoice as promptly as it is possible to do accurately.
  3. Create a process to collect the money as quickly as you can.

You don’t have to pay when you get the bill

Every time I mention slowing down payments, I get a segment of readers who get upset. Before we go there, let me be clear: treat your vendors fairly.

The reality is, you aren’t obligated to pay someone the day you get the bill.

We want to pay as slowly as reasonable. Each business and person will have a different definition of what reasonable is.

If billing subcontractor work to the customer, use a pay-when-paid model if possible.

For all else, understand their payment terms and your cash flow, then pay when optimal based on both. Sometimes that can mean paying a week or two after receiving the bill, other that could be 30 days plus.

When you can tell people when they’re getting paid and follow through, they’re typically pretty forgiving. I’d even argue they prefer that over the unknown they get from others.

Next week we’ll talk about inventory, growth, taxes, leverage, and more… See you then.


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