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Escape from the Cash Crunch
Alan Salmon

When you review the financial statements of many companies, they look great. Revenue is positive and growing; expenses are under control; and the company appears to be profitable. So why do some of these companies fail? Usually it’s because they get caught in a cash crunch.  Their cash flow doesn’t generate the cash required to sustain their growth and profitability.

Cash flow is simply the cash that flows into the business from various sources, minus the cash that flows out.  To have a positive cash flow the balance in your bank account must be positive.

This is a basic concept, but having higher revenue than expenditures is just one of three requirements for a healthy cash flow.  There are two other key components to managing cash effectively. The first is that you need to have enough liquid assets to meet your financial obligations. Second your cash supply needs to be timely; that is you receive the required cash before you need to make your required payments. It is the failure to deal with these two key requirements that causes many businesses to run out of cash and go out of business.

These two weaknesses occur more often than you might think.  An example is a company that makes large purchases through current cash flow instead of matching the purchase with long-term funding, such as bank loan.  It can also happen if a large creditor does not pay on time.

So how can a business avoid this type of cash crunch?  There are several alternatives such as cutting costs, increasing inventory turnover, accelerating cash inflow and delaying cash outflows. 

Cutting costs can be done in most companies and can have a very positive effect if the cost reduction is done carefully.  However the downside to this tactic is that this short-term solution may restrict the growth of the company.  Business growth is usually achieved by spending on marketing, R & D, technology, and staff and this requires an up-front cash investment that creates payback later.  If the cost cutting has an adverse effect on profitability, other options should be considered.

Increasing turnover can accelerate business growth and improve cash flow.  Examples include increasing the number of customers; or increasing the number of times those customers come back; or increasing the average value of each sale. This helps build revenue and generate more cash flow into the business.

However the third option which involves accelerating cash inflow can have the biggest impact on cash flow. There are many ways to speed up the inflow of cash.  Examples include requiring payments upfront or offering early payment incentives.

The cash flow output side should be closely monitored. This involves justifying expenditures and seeking the best possible deals.  Payment due dates should also be closely monitored to avoid unnecessary interest charges.

In summary, managing cash flow requires the close monitoring of cash and some simple forecasting. If you follow the above principles, your business can maintain a positive cash position, enjoy growth and most important, be profitable.

Alan Salmon, Managing Director of Alan Salmon & Associates Inc., is a leading authority on accounting software.  He is Vice-President, Canadian Operations of K2 Enterprises, a North American consulting firm providing technology training to accountants. In addition to his work with consultants, accountants, and software companies in both Canada and the US, he is the chairperson of the Microsoft Accounting Technology for the 21^st Century  seminar series.  He can be reached by e-mail at asalmon@salmon.ca or by visiting www.salmon.ca.

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