Cash-Flow-Todd-Carrollwritten by Todd Carroll

We hear it all the time: “We were running in the black after only two years in business.” Or, “XYZ company is in the red and it isn’t looking like they’ll get out of it.”

But breaking down a company’s success (or pending failure) to red and black or profit and loss doesn’t paint the whole picture. In fact, a lot of companies that turn a profit still go out of business. But why?

Two words: Cash flow.

Cash flow is the money moving in and out of your business each month. Cash flowing in might be from customers buying your product or service; cash flowing out might be rent or mortgage, loan payments, taxes, payroll, etc. Think of it as your business’ checking account: If more is coming in than going out, you’re “cash positive.” On the flip side, if more is going out, you’re in danger of being overdrawn with the potential of not being able to pay your bills that month.

The availability of cash can truly make or break an organization. Cash flow – not profit – determines viability. In fact, a recent study by U.S. Bank reported that 82 percent of businesses fail as a result of poor cash flow management.

Cash poor and trying to cover

With more than 20 years of industry experience, I’ve worked with businesses that couldn’t understand why their income statements were showing profit, but they didn’t have enough cash to cover their bills. I often use this analogy to explain the ins and outs of cash flow management.

Let’s say you make baseball bats, and you’re currently selling them for a higher price than what it costs to make them. On the surface and in theory, that’s a profitable business. But not so fast: The wholesale customers hold invoices for up to 120 days before payment, meaning that even though you’ve made the sale and delivered the product, you might not get your money as quickly. And where it gets messy is when the suppliers who delivered the bats expect their payment as soon as the bats reach their destination, leaving a gap of up to three months after you’ve paid the suppliers to receive money from your buyers.

Those first months make it hard to meet your financial obligations, and even though you’re making a profit on each bat sold, your cash flow has come to a screeching halt.

Reversing a cash flow problem

The good news is that if you have a cash flow problem, there are factors to consider that can help you reverse it.

1. Track your spending
It’s the business owner’s duty to track spending, knowing exactly what you’re spending and where you’re spending it. Categorize your expenses into day-to-day operations, research and development, sales and marketing, costs of goods sold, etc. Note the percentage spends for each category and analyze whether the cash distribution makes sense.

2. Benchmark
Look at other businesses and their spending patterns and use those benchmarks to spend similarly. Even more important is looking at businesses within your industry and within your company’s lifestyle stage. Comparing strategic objectives from benchmarking partners can give you a competitive advantage in the market.

3. Micromanage
It takes money to make money, but not all expenses are created equal. Every dollar you spend is detracting from your profit margin, so especially during the early stages, it’s important to consider the cost-benefit of every single expense. In fact, reconsider it a month later depending on your ongoing cash distribution analysis.

Professional insights

Sometimes the best thing you can do is hire an outside perspective when it comes to how each component of your business affects your cash flow. At The Whitlock Company, we can help you understand and manage your financial spending each month to make it easier to grow your business without creating a crisis in the process.

Contact us today for a consultation; we’d love to learn more about your company’s unique needs and offer potential solutions from outsourced accounting to cash flow management.

Todd Carroll is a Manager at The Whitlock Company, an accounting firm bridging the gap between traditional and forward-thinking accounting through outsourced accounting and CFO services. Todd works closely with businesses to help them make smarter and more informed business decisions with a proven track record to start, scale and optimize business operations to achieve organizational success.