Making Sure there’s Money in the Bank

Comments (1) Posted By Joe on August 15, 2011 in Business Basics

Though it's key to small business success, cash flow management skills often elude even seasoned entrepreneurs..Photograph by roberthuffstutter

Cash flow management skills are key to small business success, but they often elude even the most seasoned entrepreneurs. Photograph by roberthuffstutter

The aspiring entrepreneur tends to concern himself with superficial things: his business’s logo, the color of his restaurant’s tablecloths, and if he’s really serious, the style of his TV commercials.

Once the business has launched and bills are due, though, a more pressing concern takes shape:

“The number one issue small business owners face is managing cash flow,” said Pankaj Amin, a seasoned entrepreneur and volunteer instructor with the Intersect Fund.

For seven years, Amin owned Affinitel, a San Francisco-based company that sells and maintains phones for clients including corporations, universities and government agencies. Earlier this year, Amin sold Affinitel and moved to New York to plot his next move.

Amin said cash flow management stands out among a small business owner’s duties because of the emotion it evokes. Needing to redesign your website is one thing; failing to make payroll is quite another.

The key to avoiding cash-strapped stress, Amin said, is to make sure you understand your business’s cash cycle. A cash cycle is the time that elapses between the day you spend the cash necessary to fulfill an order and the day you get paid.

For some businesses, this is simple: a hot dog cart owner buys hot dogs he expects to sell within a few days. If one week passes between the day he bought the dogs and the day he sold them, his cash cycle is one week.

For other businesses, especially ones that bill their customers after the work is done, mapping a cash cycle is a little trickier. For example, the cash cycle of many house painters looks like this:

  • Day 1: Get hired by client to paint her house; buy the paint, rollers and slip covers needed for the job. Have to wait until weekend, a few days away, to begin work.
  • Day 5: Begin painting the house
  • Day 9: Finish painting the house
  • Day 11: Send the customer an invoice
  • Day 40: Receive check from customer

This house painter’s cash cycle is 40 days; that’s how much time passes between the day he bought the necessary materials for the job and the day he got paid.

Once the painter knows this, the next question he must ask is how much it costs to run his business for 40 days. He should be thinking of any bills that will come due, any employees he must pay, any licenses he must renew, and any other fixed costs he’ll incur. Whatever this figure is – let’s say $5,000 – he should keep double that amount in his bank account.

It’s a safe strategy, but keeping that much in the bank is difficult. How should our house painting friend shore up his cash reserves? Here are three methods:

  • Require customers pay 50 percent of their total bill the day they retain his services.
  • Send invoices sooner
  • Insist customers pay him more quickly

  • The first two are manageable; the third can be tough. Amin said his most profitable client at Affinitel was a large school district that frequently waited 10 months to pay his company for services rendered. Surely a pain, but because Amin’s competitors lacked the liquidity to tolerate a 10-month cash cycle, his company was the clear choice. Its strong cash flow management earned it a steady, lucrative contract.

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