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10 Important Tips for Cash Flow

A small business owner or startup CEO can never worry enough about cash flow (or the lack thereof). As an outsourced CFO service provider, we live, breath, and sleep thinking about how to manage and improve cash flow for the companies we work with here in the San Francisco Bay Area.

An article in Entrepreneur Magazine called “10 Critical Cash Flow Rules” has some very good, practical tips and advice about cash flow.

Here is a summary of the 10 tips:

1. “Profits aren't cash; they're accounting.”

This is probably the hardest concept for most business owners and CEOs to understand. A company that is profitable can actually still have a cash flow crisis or shortfall. Understanding how the P&L (Income Statement), Balance Sheet, and Cash Flow Statement all work together to provide a complete view of the business is critical.

2. “Cash flow isn't intuitive.”

“Don't try to do it in your head. Making the sales doesn't necessarily mean you have the money. Incurring the expense doesn't necessarily mean you paid for it already. Inventory is usually bought and paid for and then stored until it becomes cost of sales.”

Whereas profit is fairly easy to understand for most people (i.e., sales minus expenses equals profits), figuring out how cash flow can get sucked up into Working Capital items (e.g., Inventory, Accounts Receivable, Accounts Payable) is not all easy.

3. “Growth sucks up cash."

With Silicon Valley’s “Growth at All Costs” mantra, this point reveals the Achilles Heel. Growing sales and any company usually consumes a lot of cash in the short-term. Understanding the Cash Conversion Cycle is crucial for any growing business.

4. “Business-to-business sales suck up your cash.”

“The simple view is that sales mean money, but when you're a business selling to another business, it's rarely that simple. You deliver the goods or services along with an invoice, and they pay the invoice later. Usually that's months later. And businesses are good customers, so you can't just throw them into collections because then they'll never buy from you again. So you wait. When you sell something to a distributor that sells it to a retailer, you typically get the money four or five months later if you're lucky.”

B2B sales, which can be enormously profitable, can place enormous pressure on cash flow due to the stress on managing Accounts Receivable (AR) and Accounts Payable (AP). Cash flow is usually harmed by the growing Working Capital needs to finance B2B sales.

5. “Inventory sucks up cash.”

Especially for retailing and manufacturing businesses, negative cash flow is a result of the necessity to buy product inventory from wholesalers and / or to buy materials to build your products before you can even sell it. In essence, suppliers will have to be paid far in advance before a company will receive cash from its customers.

6. “Working capital is your best survival skill.”

The key drivers of Working Capital are typically Accounts Receivable, Inventory, and Accounts Payable. Often, the weaknesses in a small company or startup that affect cash flow related to bloated, slow-moving Inventory, slow-paying customers, and / or paying vendors too quickly.

7. "Receivables" is a four-letter word."

Just because a company may be growing sales nicely, it doesn’t mean that it turns into positive cash flow if Accounts Receivable is growing even faster. This is usually the case when customers take their time in paying their invoices and the company is not focused on the AR process.

8. “Bankers hate surprises.”

“You get no extra points for spontaneity when dealing with banks.”

No truer words were spoken than this. Banks are inherently risk-averse for a variety of reasons. It’s important to maintain proactive communication with banks in both good times and bad times.

9. 3 Key Metrics to Watch:

"Collection days" (aka DSO) measures how long customers take to pay your invoices.

"Inventory turnover" reflects how effective and lean your inventory is compared to your sales volume.

"Payment days" is the opposite of DSO and measures how quickly you’re paying your vendors.

10. “If you're the exception rather than the rule, hooray for you.”

However, to be honest, in our many years experience providing outsourced CFO services to companies of all sizes and types, we’ve never seen a company, no matter how well-run, that couldn’t improve their cash flow significantly.

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