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2
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7
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2018

6 Reasons Your Company's Cash Flow Is Tight

Patrick Russo

What causes tight cash flow and how can you, a business owner, have healthier cash management?

Cash flow is the lifeblood of every business. When it is tight, cash flow makes it difficult for companies to grow through investing in new equipment or products, raising capital, or even financing debt. A distraction is also created for owners and managers who are trying to build long-term enterprise value, as tight cash flow means increased concern for covering operating costs to keep the business afloat.

Too much cash, on the other hand, could mean missed opportunities and slower growth. The acid-test ratio is a simple way to quickly determine whether your business is holding too much cash - cash that could be effectively invested back into your company, or else distributed to key stakeholders, like investors or employees. Otherwise known as the “quick ratio,” the acid-test ratio is a liquidity test that will also help you determine how much short-term debt you could pay off before having to sell inventory (inventory for which there may not be a solid market at a given time).

What causes tight cash flow and how can you, as a business owner, have healthier cash management? When it comes to evaluating your company’s cash flow situation and looking for ways to improve, the following areas are good places to start.

Vendor Terms

Do the phrases ‘Net 30’ or ‘Net 15’ mean anything to you? If not, it may be time for a quick review of your vendor terms to see if there is any room for improvement. If your business has not had time to build positive credit, it may be difficult to get vendors to open a credit account for you - this is still the goal, however. By paying bills with a credit card, or else pushing their due date out 15, 30, even 60 days, you are able to keep cash in your business longer and increase your current ratio.

Accounts Receivable

How wide is the spread between your profit and cash flow? Asked another way, how long does it take for cash to hit your bank account after seeing the corresponding revenue show up on your income statement? If your accounts receivable balance is growing month to month, it is a good time to evaluate your collections process. Improved workflows could help convert those receivables to cash sooner. Those workflows could include incentives to customers for early payments (or penalties for late payments), more frequent reminders to pay, and easier payment methods (e.g. electronic payments).

Borrowing Costs

If you have a loan on your books, another potential cash flow improvement is to renegotiate the terms to reduce payments as much as possible. The reduced payments will help your quick ratio, or short-term cash situation, although it will make your loan more expensive in the long run. Depending on your specific situation, this short-term liquidity boost may be a helpful tool for climbing out of the bottom of a revenue cycle.

Payroll

Generally, keeping your payroll cycle in line with your cash receipts cycle, you can avoid the pinch commonly felt by business owners when payday is at hand. Paying employees weekly (as opposed to bi-weekly or monthly) helps improve cash flow predictability, which can help if you have cash flowing in sporadically throughout a given month.

Setting employees up on direct deposit also improves cash flow predictability, as you know exactly when cash is leaving your bank account, rather than waiting for employees to cash their paper checks.

Unnecessary Overhead

What is your operating expense ratio? Decreasing this percentage by cutting unnecessary, or superfluous, costs helps improve cash flow and long-term profitability. While this may seem obvious, it is a doubly important measure, as it will also help you determine how efficiently you are adding top-line revenue, or sales. If your operating expense ratio increases proportionally with revenue, then it may be more difficult to improve cash flow simply by increasing sales.

Monthly Cash Budget

A monthly cash budget is a great way to prepare for any short-term cash crises. Your accountant or financial operations team can help you build one. They will likely analyze a few of your company’s financial ratios and recommend steps for improving cash management in your specific situation. Financial ratios help measure things like working capital and profitability against industry benchmarks, or other similar companies. These measurements help businesses create more insightful cash budgets that effectively improve their cash situations over time.

As you evaluate the above areas and take advantage of opportunities, your cash flow, the lifeblood of your business, should see some healthier circulation. This improvement will help your business become more sustainable, while simultaneously allowing you to shift your focus to more impactful, long-term value creation.

Want to learn more about what working with LUCA looks like? Our team would love to hear from you.