Cash flow is part accounting and part crystal ball. You need to estimate what your cash outflow will be, and that is predictable to a degree. But if this is your first year in business, estimating your cash inflow is largely guesswork. Optimists often expect more revenue than the business actually produces. Sometimes the business is making enough sales, but clients are slow to pay, and this will put the business in a bind paying its own bills.
Other business owners simply skip cash management altogether because they don’t think it will matter. Bad idea. Cash flow is a make or break proposition for businesses. Businesses that fail have almost invariably failed to have a cash management strategy.
The AllBusiness.com Adviser article this week in the San Francisco Chronicle offers Ideas for keeping your cash flowing. Included are a number of tips. One that I think is key is having a cushion to cover a cash-flow crunch. This might be savings or a line of credit. Hopefully, you prepared for this before even opening the doors for business.
Gene Marks addressed the same topic week in his Forbes column titled An Entrepreneur’s Most Important Asset. He offers this advice to help you get beyond sheer guessing:
When it comes to how much cash to keep around, most experts agree on a basic rule of thumb. “Keeping enough liquid assets to fund the next six months has always worked for me,” says Gary Harpst, owner of Six Disciplines, a small-business consulting firm in Findlay, Ohio. “This allows adequate time to arrange financing or lower expenses if necessary.”
How do you know how much protection a certain amount of cash buys you? Start by comparing the amount of time it takes to collect money from customers with the amount of time you have to pay suppliers. The lifespan of these “working-capital” accounts will dictate how much grease you need to keep the gears turning on a short-term basis.
Be conservative in your revenue estimates, and go ahead and project your cash flow for the coming 12 months. Revisit it each month as you get more data on how sales are going and how customers are paying. And don’t forget to heed the expenditure side of the equation. Manage costs fanatically, especially during this first year.