The Art Of Managing Cash & Profits
 By Patrick L. Wynne

You don’t have to be in business very long to learn the truism that, “Cash is king.”

Without cash, you can’t pay bills. Sure, you can defer payments by relying on credit, but credit accounts come due too, and you need cash to pay them.

If your creditors and vendors demand payment monthly, you can find yourself in a pinch if you allow your clients and customers up to 60 days to pay. If your income doesn’t keep pace with your outflow, you’ll soon be cash poor. This is why the quickly cultivated love of cash on hand is entirely understandable.

But on the flip side of this economic equation lies the danger of gauging your financial health principally on how much operating cash you have.

Although a cash flow consistently in the black certainly is a good thing, it doesn’t necessarily translate into the best thing: profitability. Cash on hand doesn’t mean that you’re making a profit.

And it’s profit that keeps you in business. If you’re unprofitable long enough, you’ll eventually have to close up shop.

The art of small-business finance is just like that of big business, except more so. That’s because small margins of error can cripple or kill a small business much more easily than they will a huge corporate concern.

Your first task is to ensure that your business’ life blood is continuously flowing by making sure to have a positive balance of cash on hand.

Tracking your cash flow is important because you’ll learn how to read the warning signs of a cash shortfall. Those warning signs can signal well in advance how to avoid a crisis by reducing spending or increasing efforts to attract new business.

Part of that task is to properly budget in advance for supplies, debt payments and other operating expenses by accurately forecasting the cash that will be on hand in the future, not merely counting the dollars in the bank for the present.

Your next task is to routinely divert some of that precious cash to a reserve account that is protected from the day-to-day costs of doing business.

Your projected cash coming in may cover your projected cash going out if everything goes as expected. However, if a client is late in paying, or goes belly up, you’re still on the hook for those monthly expenses, despite the dip in your monthly income. That’s where the cash reserve account comes to your rescue.

There are as many different recommendations for how much to squirrel away in your cash reserve as there are folks who make recommendations. One rule of thumb might be to reserve enough cash to cover three months’ worth of operating expenses. Or, if you’re even more conservative, six months’ worth.

But the point is not some dogmatic amount. The point is to know your business well enough to reserve adequate cash to ward off catastrophe. You don’t want to find yourself so cash short that you are forced to borrow money simply to pay operating expenses.

All of this points up the basic difference between cash and profit. Cash is what pays expenses (and taxes). Profit is what’s left after expenses (and taxes) are paid. Don’t mistake cash for profit, even though it’s tempting to do that.

One last important aspect to the cash/profit reality is that even when you enjoy booming sales, it doesn’t necessarily mean you’ll be blessed with lots of cash.

Unless you receive cash on delivery for everything you sell, your accounts receivable will always lag behind your sales. And if your customers are not making timely payments, sales won’t automatically translate to a positive cash flow, let alone generate enough to sock away in that all-important cash reserve.

(Posted May 2006)

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