Making a profit is important for a small business. If you lose money long enough you’ll eventually have to shut your doors. Many small business owners do a decent job of watching their P&L statements, but some neglect something else that is just as important. They don’t pay attention to their cash flow. A business can be making a profit, but if it runs out of cash it’s in trouble.
Without cash you can’t make payroll, pay your suppliers, market your business properly, pay your bills on time and offer the kind of customer service you may want to provide. If you struggle from week-to-week to meet your obligations your business is in trouble.
How can a small business be profitable and run into cash flow problems? The easiest way for that to happen is to have too much out in accounts receivable. If your customers are holding your money for 60-90 days or more before paying you it won’t be long before you develop a cash flow problem. On paper your business is profitable, but your bank account paints a different picture of the financial condition. Until the money owed you is in your hands you don’t have it.
One company calculates that an account receivable that is 90 days old costs the company .20 on every dollar owed. Based on that calculation, if someone owes you $1,000 for 90 days, that $1,000 is now worth $800.00. That’s a significant loss and may account for much of the profit that deal might have generated.
To avoid cash flow issues it’s necessary to keep the money coming in. The best situation is when you sell a product or provide a service and you receive payment when that occurs. Retail often works this way, and assuming sufficient sales and a proper margin these businesses will have fewer problems with cash flow. However, a service company may have money out in accounts receivable due to the nature of their business. Such companies must be very diligent in limiting the amount of A/R they carry on their books.
- They need to have clear policies in place, written down in their contracts with their customers, for when payment is expected.
- Business owners must have a weekly A/R meeting with the necessary people to understand how much is in A/R and how old these accounts are.
- Someone with negotiating skills must make the collection calls to any customer who has not paid his bill within the agreed time stated in the contract.
- Apply late charges to any overdue invoices. These may be limited by state law, and it is a good idea to check with your attorney on this and with all the collection attempts outlined in this post. Do not give someone who will not pay his bill a reason to take YOU to court!
- Be willing to fire a customer who will not pay his bill on time. Once you have collected the amount you are entitled to you may want to reconsider whether you want to do business with this person or company again.
I was once told that having money on A/R was a good thing because it meant that money was coming in. That’s true only if it is coming in as promised. Many small businesses will tell you that when the US economy tanked in 2007 that it became a lot more difficult to get the money they were owed. I much prefer having the money in hand.
With cash I can make payroll, pay my bills, advertise properly, grow the business, be ready for emergencies and have a lot less stress. That’s why I say cash is king. Consider if reducing your A/R and increasing your cash reserves in 2016 might be a worthy goal.