One of my main complaints with bookkeepers, accountants and other professionals in the accounting and financial profession is their obsession with net income when advising their small business clients, instead of focusing on cash flow. As I mentioned on my previous posting, cash flow is the life blood of any business. However, for a small business it is even more critical to have a tight grip on cash flow management. Small business owners must insist their accountants, CFOs, bookkeepers, CPAs to help them with the cash management instead of worrying so much about the net income.
Why is cash flow management so important for a business?
The main reason, your business could go bankrupt while you continue showing profitable financial statements. Many of you may be thinking; What? When you have been in this industry for over 20 years you have seen your fair share of things that will make you go hmmm. This is one area that baffles many small business owners; "But my CPA showed my financial statements last six months showing me a profit...." when they get hit by a Mac truck in the middle of the highway when the news hit them that they are bankrupt or in a serious cash flow deficiency.
When looking at cash flow management you must look at both extremes, another mistake that many financial professionals make is to only focus on the cash flow deficiency side only. If your business has been blessed with excess cash, the excess cash should never be idle (i.e. invested in marketable securities, buying productive assets (such as computers or machinery and equipment), reducing debt, etc).
How much cash balance should I hold?
This is an awesome question and the answer is depends. The answer to this important question is not so simple since it is affected by many external factors:
1. State of the economy - If economic uncertainty exists, the conservative
strategy is to retain higher cash balances.
2. Rate of return from marketable securities you can earn
3. Uncertainty about future cash flows
4. Ability to borrow on short term notice
5. How long funds are needed?
To name a few.
If there is an inadequate cash balance, you face the following adverse effects:
1. The negative impact on your credit rating of not paying a creditor on time.
2. The possibility of losing a cash discount and incurring late fees.
3. The inability to make a bargain purchase because of lack of funds.
4. The payment of brokerage and administrative fees when marketable securities are sold or a bank line of credit is used to obtain funds.
5. The possibility of having to borrow at high interest rates.
6. The need to sell assets to derive cash, such as selling accounts receivable to a
third party.
The goal of cash management is to have sufficient cash balances for transactions while avoiding excessive balances. It is a delicate balance that must be watched on a regular basis, which baffles me how can business owners (or their respective person in charge of their financials) operate without looking at their financial statements for several months. Once again, cash flow is the life blood of your business. More time is spent on the type and quality of their stationaries (not to say that it is not important) than in the most important aspect of business which will determine if the business will be around to see the use of the stationaries.
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