“Cash is King” as the old saying goes.
In business cash serves several purposes. It meets cash obligations, can be retained for unexpected issues, and is invested for future needs of the business.
The timing of cash inflows and cash outflows is critical for the success of a business. The first step to tame cash is to understand the operating cycle.
The operating cycle (or cash cycle) is the flow of cash through a business. The first activity is cash infusion. This infusion comes from loans from creditors, investments from owners, and cash received from the sale of goods or products.
The second activity is the production of goods and/or services. During the second activity employees are paid; buildings, equipment, materials, and supplies are purchased.
The last stage of the operating cycle is where cash is received by selling goods and services. The monies are then used to pay taxes and debts, return money to owners, and continue the business activity (starting over at the first activity).
Unfortunately, there are many areas when a breakdown in cash can occur. One of those areas involves current assets.
Current assets are items the business owns that will convert to cash in one year or less. Current assets are usually cash, marketable securities, inventory, and account receivables.
The most difficult of the four current assets to convert to cash is accounts receivables. A quick tip to overcome accounts receivable problems is to closely monitor it and have a firm collection and credit policy before extending credit. If possible avoid extending credit.
Another deterrent to the smooth flow of the operating cycle is the time between buying producing inventory and selling the inventory. The “Just in Time” concept can be a valuable tool to help in the timing of converting inventory to cash. Selling old and obsolete inventory is another important way to free up cash.
Growing a business too fast can also impede positive cash flow. According to David H. Bangs, Jr., author of Business Planning Guide, a business should not expand until employees' overtime is piling-up, there is no more room in the facility to grow, and there is a waiting list of customers.
It is wise to develop a financing plan that incorporates several “what-if” analyses before deciding to expand a business.
Having a cash reserve is critical to the success of a positive cash flow. The experience of Joseph as he interpreted Pharaoh's dream of seven fat cows and seven thin cows is a reminder to save during the high growth thriving months. It is wise to have money set aside that can cover necessary obligations during lean months. Understanding and managing cash inflows and outflows can increase the probability of business success.