Having Enough Cash to be Healthy

Don’t have any cash in case of emergency, to fund payroll, etc. We’re operating very close – chasing accounts receivable to get money in, and it goes right back out again. Feels like a treadmill and that we’re not making progress. We have loans to pay off, which we’re doing, and some old bills that we owe to vendors who have been very patient. Have to get out of this month to month hole. It’s exhausting. Every month we ask ourselves, are we going to make it.

Thoughts of the Day: Cash reserves are essential to having a healthy business. Working through the demands on revenue takes a plan and patience. Know what your goals are. Be honest with your vendors and negotiate terms where possible. Identify a realistic plan to work your way out of the current situation.

Every business needs cash reserves to function effectively. When sales are down, cash reserves are often what get chopped, making it much harder to manage the business. It takes real discipline to protect cash reserves. Set a minimum goal and protect those reserves at all costs, even if the temptation is to use them up to pay bills.

Money coming in from customers goes towards paying for lots of things. Cost of goods sold, overhead, debts, investments in the future, paying for taxes, rewarding shareholders are just a few of the demands placed on revenue. Put together a game plan for how much revenue goes to pay for each demand.

Some demands need to be calculated as percentages, some as fixed costs. Some demands only happen in relationship to other things. For example, cost of goods sold gets calculated as a percentage on the P&L. But it may or may not have an actual impact to cash depending on whether it’s paid for out of the checking account as it’s incurred or charged to a credit card, or if you’ve negotiated payment terms with your vendor.

It’s easy to build up debts if you’re paying for things on credit lines and credit cards, or if you’ve negotiated longer payment terms with vendors. Keeping track of how debts are building up is essential, and that’s what the balance sheet is for.

Set goals that will keep your business healthy. For example, keep 1 month cash on hand at all times. Build up cash on hand to 3 months of overhead expenses. Then build to 6 months of overhead expenses sitting in cash or cash equivalents (CDs). Once you get to this kind of savings, you’ll be able to sleep at night.

Reduce debts to no more than 2.5 times equity, and keep current assets at 2x or more of current liabilities. These two ratios will help you manage the debt load. If those ratios aren’t in line right now, commit to putting $1 towards debt reduction and $1 towards savings. This will help you reduce debts as you build up cash.

Often owners ask, “Why shouldn’t I just put every dollar towards paying down my credit cards and credit lines, instead of putting money towards cash reserves?” The answer is simple. If at any point in time your credit line is reduced or cut, or you have to pay taxes and your credit line is maxed out, you’re in big trouble, unless you have cash reserves on hand. Cash reserves give you freedom to operate, and also boost the ratios on your balance sheet. Pay attention to them.

If you don’t have enough cash to pay off everything, approach vendors who have a vested interest in your success. These are most often your cost of goods sold vendors. Ask them for terms. If you have a balance build up with them, negotiate pay-down terms on the old balance. Many vendors would rather see you stay in business and continue to buy their products and services, so long as they can be confident that they won’t get burned.

Take a close look at what volume of sales your company needs to be profitable. Is the current cash flow issue coming from a couple of down months, or is the business trending downwards overall? Is this a seasonal problem, requiring a different sales strategy to plug volume into the low months?

Figure out how much revenue your company needs in order to pay off all debts and to build up cash reserves. Set a target for shareholder distributions, allowing you as owner to receive adequate compensation for the risk you take to run and fund the company in low periods. Remember that for every dollar of debts and cash reserves and shareholder distributions, you have to net $1.33 to pay for taxes, unless you have loss carry forwards from previous years.

Face the music by putting together a plan for how to move forward. If you don’t know how to write a plan, get someone to help you. Operating with your eyes wide open will help you better manage the business.

Looking for a good book? Cash Flow Analysis and Forecasting: The Definitive Guide to Understanding and Using Published Cash Flow Data, by Timothy Jury.