Chapter 19
CASH FLOW MANAGEMENT

IN This Chapter
The cash flow cycle
Cash controls
Preparing cash flow projections
Managing surplus cash

Introduction
Cash is the lifeblood of business, so you must pay careful attention to your cash flow. This is particularly true for small businesses, which tend to operate on a very tight budget—the equivalent of living from paycheck to paycheck. Careful cash management will keep your business from becoming delinquent on its debts and protect its credit rating.
It’s equally important to manage your cash position carefully when your business is flush with cash. Idle cash doesn’t help profitability, but planning for growth often presents cash flow management challenges. For instance, you might encounter a cash drain in the beginning as you establish new markets or open new stores.
Whether times are good or bad, careful cash flow management is essential.
The Cash Flow Cycle
The cash flow cycle (also known as the cash-to-cash cycle) represents the length of time that cash is tied up in business operations. The cycle looks like this:
How long cash is tied up in this cycle depends on how long your inventory sits before being sold, how long your customers take to pay you, and how long you take to pay your suppliers. Managing cash flow means managing these activities. If you want to shorten the cash flow cycle, you can speed up sales, speed up collections from credit customers, or slow down payments to suppliers.
Managing Inventory
Total inventory cost is a function of two variables: the quantity of goods held in inventory, and their per-unit cost. You can reduce your investment in inventory by decreasing either its quantity or its cost. Reducing per-unit cost calls for careful attention to purchasing. A manufacturer must also monitor labor and overhead costs.
Businesses hold inventory to meet actual and potential customer orders, to guard against supplier shortages, to corner the market, or because they’ve taken advantage of quantity discounts offered by suppliers.
Buying strategies have a major impact on inventory turnover. For each item in your inventory, you must decide how many to buy, how much to pay and when to order. Standard mathematical models can help you do this. One is the Economic Order Quantity (EOQ) model, which calculates the optimum quantity of inventory based on the cost of ordering and storing the goods, anticipated sales, and per-unit cost. We will discuss additional inventory control systems in Chapter 24 Supply Chain Management.
Inventory Turnover Ratio
Ratio analysis is a means of evaluating how effectively you’re managing your cash flow cycle. The inventory turnover ratio tells you the average number of times your inventory sells during the year.
To calculate the average number of days in inventory, divide 365 days by the result of the previous calculation.
Cost of Goods Sold
Average Inventory
For example, let’s assume the following for Pat’s Machine Shop:
365 Days
Inventory Turnover Ratio
Therefore, Pat’s inventory turns over 13 times per year. Now, let’s calculate how many days it takes to turn over, on average:
$3,900,000
$300,000
= 13
Pat’s inventory is in stock for 28 days before it sells. Whether this is high or low depends on industry averages, geographical location, past performance, the economic outlook and related issues.
365
13
= 28 days
To decrease the cash-to-cash cycle, Pat could try to turn her inventory more often, either by increasing sales or by eliminating obsolete and slow-moving products.
…
I was born and raised in Chino, California, but I moved to Houston about six years ago. I met Lucie out here, and we got married about a year later. I drove a cab for a while, but I didn’t like it much. I wanted more out of my life, so I started thinking about other options.
Back in California, I was involved with the Lowrider community. Airbrush artists like Wiro and Fonzy were my heroes growing up, and I was just starting to make a name for myself as an airbrush talent when I moved. So unlike a lot of people, I didn’t have to sit around trying to figure out what kind of business I wanted to start.
I already had the equipment for airbrush work, and I also had the talent and the energy. What I didn’t know was, that isn’t always enough.
Al Briones runs a popular airbrush shop in Houston’s Second Ward. He does custom work for cars, trucks, vans and motorcycles.
When he first decided to pursue airbrush work, he never thought about running a real business out of a shop. He was just looking to make some extra money on the side, when he wasn’t driving a cab around Houston. His longtime hobby seemed like a good way to go.
He had no marketing plan and kept no books or records. He didn’t think he needed them, because he was working off the books. His business was all word of mouth, and he could only handle one vehicle at a time in his small garage. He made about $2,000 a month on average.
At first I was just doing odd jobs off the books, like most people do at some point. But then more business started coming in, and I started feeling like I wanted to be legit. I wanted to call attention to myself. Working under the table, it was like I couldn’t be proud of my skills. I felt like I was hiding.
I’d drive by these other shops where the work wasn’t nearly as good as mine, and they’ve got all the big signs out, saying “Best in the Barrio.” Those guys weren’t hiding themselves. They had a nice big work space, good ventilation, everything. And I thought, “If they can do it, I can do it better. If they’re getting by, I’m gonna get rich.”
Even after he decided to start a legitimate business, Al didn’t give much thought to financial management. He figured his energy, talent and self-confidence would get him where he needed to go. Once he got there, he could easily hire someone to do the books for him.
…
Managing Accounts Receivable
Managing accounts receivable entails balancing financial and marketing goals. For instance, new credit customers may help you meet sales goals, but if they prove to be slow payers, your cash flow cycle may be lengthened, weakening your financial position. On the other hand, if you don’t offer good credit terms, you may lose sales.
Receivables Turnover Ratio
Ratio analysis can help you evaluate the effectiveness of your credit policies. The receivables turnover ratio tells you the average number of times you collect receivables in a year.
Once again, you can convert this into days by dividing the ratio into 365, which gives you the average collection period:
Net Credit Sales
Average Net Receivables
Here’s an example for Pat’s Machine Shop. The receivables turnover is:
365 Days
Receivables Turnover Ratio
And the average collection period is:
$7,200,000
$650,000
= 11
365
11
= about 33 days
On average, Pat’s customers take 33 days to pay. As with average days in inventory, whether this is low or high depends on a variety of business and economic factors.
To decrease the cash-to-cash cycle, Pat can reduce the average receivables collection period by adjusting her criteria for extending credit, her credit terms or her collection activities.
Credit Policies
When considering credit policies for your customers, it’s best to look at the same factors banks and other lenders evaluate:
Credit history. Review credit history for new and existing customers. Don’t assume that circumstances remain constant for your customers. Pay close attention to customers who ask for increased credit or special terms.
Character. Check your customer’s reputation and references.
Capacity refers to your customers’ ability to pay the debt. Look at their past and present financial reports, and observe their current operations.
Collateral. Usually, there is no collateral for an accounts receivable transaction. In some cases, you may be able to retrieve the merchandise.
Conditions. Consider general and local economic trends.
Capital. Customers in a solid financial position are less likely to default.
Credit evaluation won’t avoid all bad debts, but it can reduce their risk and severity.
Setting credit terms
You should have clearly written procedures stating what information you require from credit applicants and which employees have the authority to grant credit.
Standard cedit terms include the credit period and cash discounts. Extending your credit period lengthens your cash flow cycle, meaning that your bills may come due before your customers pay. But if you shorten the credit period too much, your customers might become delinquent on their accounts or start buying elsewhere. Finding the optimal credit period often takes some experimentation. It’s wise to research your industry averages and check what your competitors are doing.
Cash Discounts
Many businesses offer cash discounts for early payment. For example, you might offer your customers “2/10, net 30” terms: Customers who pay within 10 days of the invoice date get a 2-percent discount. Otherwise, the payment period is 30 days.
The discount is the price your business pays for these benefits. Whether it’s worthwhile to take a little less money in order to get paid a few weeks earlier depends on your market and your goals.
Managing Collections
Few business owners enjoy trying to collect from delinquent customers. Collection agencies will do it for you, but they charge a high fee; most businesses resort to this only after other efforts have failed. How much effort you put into collecting receivables is a tradeoff between the time and money it costs versus the cash you lose if you fail to collect.
The best strategy is not to let accounts become delinquent in the first place. Careful credit checks will help, as will a billing system that generates timely, accurate invoices. If customers know you’ll notice when they’re delinquent, they’re more likely to pay on time. Errors on invoices can cause disputes and delays, so make every effort to avoid them. Personally contacting late payers can also help to keep them on track.
Aging accounts receivable
An aging report lists receivables by how long they have been outstanding, which allows you to identify slow-paying customers, follow up on collections, and evaluate your credit and collection policies. See example below:
Assigning and Factoring Receivables
Assigning and factoring your receivables are effective ways of speeding up cash inflows, but they can be expensive. Assigning receivables means using them as collateral for a short-term loan. (This is also known as pledging your receivables.) The lender reviews the collectibility of your receivables and lends you some percentage of the total. You repay the loan, plus interest, as you receive payments from your customers. Interest rates will usually be several points above the prime rate.
Factoring receivables means selling them to a financial institution. The factoring agreement may be on a “with recourse” or “without recourse” basis. If factored with recourse, you still have a collection risk, because the financial institution may seek funds from you if collection yields are less than anticipated. If factored without recourse, the financial institution cannot seek additional funds from you. As you can imagine, financial institutions will be very careful about entering into this type of transaction.
The amount offered depends on the age and quality of the receivables. For this reason, factoring is usually a poor choice for small businesses, unless its receivables are of very high quality and the owner needs cash very quickly. One advantage of factoring is that the factor typically assumes all administrative responsibility for collection. Customers send payments directly to the factor. Some businesses see this as a way to reduce overhead costs by eliminating some accounting tasks.
Credit Cards
Many businesses shift credit risk and collection burdens away from themselves by accepting credit cards. Businesses that accept credit cards typically receive only 95 to 98 percent of the total sale amount. However, the institution that issued the credit card bears the risk of nonpayment.
To become a credit card merchant, you must sign an agreement with a bank or other financial institution offering the service. These institutions offer many different services and terms, so shop around before signing an agreement.
…
A year later, Al’s airbrush shop was thriving, and Lucie’s brother Ciro was keeping Al’s books. Ciro was living with the couple while finishing up his last year of college—he was studying business and accounting—and handling Al’s accounts was his way of paying rent.
Ciro often said that Al needed to get more involved in the financial side of managing the business. But Al always seemed to have something else going on. His garage was always full, for one thing, and he figured that as long as he had customers, the best use of his time was to serve them.
It bothered Lucie that Al didn’t take more of an interest in management issues, but she knew Ciro was a hard worker and she trusted him to take up the slack.
And for a while, Ciro did exactly that. But as time went on, he began to feel like there weren’t enough hours in the day to do all the things Al expected of him. While he dealt with one crisis, three more would come up.
He tried to talk to Al about it, but Al was always dealing with customers and painting cars and trying to meet deadlines. He was the most energetic guy Ciro had ever known. And he was never more energetic than when he was looking for an excuse not to talk about accounting.
…
Managing Accounts Payable
The final component of the cash flow cycle is how long you take to pay your bills. Ideally, you’ll pay bills when they’re due (or, if you want a cash discount, just at the end of the discount period).
Obviously, you don’t want to become delinquent. But you don’t want to pay too quickly, either. Instead, you should prioritize and schedule your payments:
High-priority bills must be paid on time to keep your business running, to avoid penalties, or to comply with legal requirements. They include sales tax deposits, payroll tax deposits, payroll, lease and mortgage payments, credit card payments, and insurance premiums.
Medium-priority bills are close to being overdue or to being outside the eligibility period for an early payment discount. These bills will typically be for vendors, suppliers, utilities and contractors.
Low-priority bills have a grace period, or flexible terms, and can be paid once you’ve taken care of more pressing obligations. These are usually 30-day invoices for independent contractors, service providers and suppliers.
A tickler system is very helpful in controlling payments to creditors; it sorts bills by due date and priority.
Using a ratio to monitor payables is trickier than it is for inventory and receivables, because your suppliers are likely to offer a wide variety of credit terms. You may find it helpful to calculate the average time to pay for purchases:
Pat’s Machine Shop has the following ratio:
365 days ÷
Total Purchases
Average Accounts Payable
You can also improve your cash flow by considering how often to pay your employees. Whether you pay per shift, weekly, or every two weeks can have significant consequences for your cash flow, especially if your average receivables collection period is low. It may also be possible to schedule payroll after other major expenses, such as rent or lease payments. Check your state employment laws to find out what schedules are legal.
$51,000,000
490,000
Sales and Payroll Taxes
It can’t be said often enough: Don’t use sales tax money or payroll withholdings as working capital. The penalties for failing to make timely deposits are severe, but even if that weren’t the case, failing to make smaller, regular tax deposits will cause you to owe a large and possibly unmanageable lump sum. If you can’t handle making lots of little payments on a known schedule, you probably won’t be able to handle making a single large one on demand.
Hiring a payroll service will ensure that money earmarked for taxes doesn’t mingle with your working capital, and it can also save you from having to squander your valuable time on payroll issues. If that’s not an option right now, create a separate bank account for your taxes due and consider it off-limits for any other purpose.
Cash Controls
Internal controls protect your assets and the accuracy of your financial information. Internal controls for cash ensure that:
Cash is properly received, deposited and recorded.
Cash disbursements are properly authorized and recorded.
Cash balances are secure, accurate and adequate.
Internal controls don’t just guard against theft and embezzlement; they also reduce the number and severity of honest errors.
Authorization
Every business transaction must be authorized by someone. For cash, this is usually accomplished by having authorized check signers. Your bank maintains a signature card that must be signed by all everyone who is authorized to sign checks. Usually, the business owner will be an authorized check signer, but it’s important to have additional people on the signature card in case the owner is unavailable.
Many businesses require dual signatures on checks above a certain amount. For example, the business may require two signatures on checks greater than $5,000, and on all checks to owners and employees.
Before signing a check, always examine the invoice and compare amounts, payee and dates. If you don’t recognize the payee, ask questions or look at your authorized vendor list. Many cases of embezzlement occur because the business owner simply signs anything the accountant submits.
Businesses that issue many checks sometimes use computer-generated signatures or a check-signing machine. In such cases, internal controls must safeguard the use of the computer program or machine so that no unauthorized persons have access. Having these systems in place does not reduce your responsibility to review supporting documents.
Reconciling Bank Accounts
Businesses must reconcile their monthly bank statements with the cash balance on their books.
Reconciling accounts is often simply a matter of timing. Deposits in transit are deposits that have not yet been posted by your bank. Outstanding checks have not yet been cashed by your payee; you’ve deducted these amounts from your cash balance, but they haven’t yet been taken out of your account. Service charges may also be a reconciling item, as you often won’t know the amount of a given charge until it shows up on your statement.
Your banker can help you develop a bank reconciliation form. In fact, many banks include a form on the back of their monthly bank statement. A particularly useful method is to reconcile both the bank balance and the book balance to the correct amount of cash. Above is an example of a bank reconciliation in this format.
This format indicates the correct amount of cash, which should then appear on the balance sheet. In this example, Pat must adjust her books to reflect the $15 service charge and the $30 error.
Bank statements should be mailed directly to the employee responsible for reconciling them. Other personnel, especially those charged with writing checks or keeping the accounting records, should not have access to the statements.
Segregation of Duties
Ideally, different people should handle authorization, recording and custodial functions. You should never allow one employee to handle a transaction from beginning to end. In particular, the person who handles the cash should not be in charge of keeping the books.
Here are some ideas for segregating duties in a business with plenty of people to cover all the tasks. Most small businesses don’t have the luxury of going to this extreme, but you can use this model to help you segregate the tasks as much as possible.
…
One summer afternoon, Al had a rude awakening. When the mail came, he went through it and actually looked at the bills instead of just passing them on to Ciro. Almost every envelope he opened showed a past due balance—most of them were second or third notices, and one was from a collection agency.
It was clear that something had gone very wrong, and Al had a pretty good idea of who was to blame.
I felt totally betrayed. I’d been working so hard and doing so well, building up good credit and doing everything by the book. I had a lot full of cars, and I was out there working 12 hours a day. No one could say I wasn’t holding up my end of the business. How was I supposed to do all that and take over Ciro’s job, too? It was crazy.
Luckily, I had some time to calm down before Ciro and Lucie got back from the supermarket. I was able to think about what I was going to say, instead of just blowing up. I was still mad, though. This was my future at stake.
…
Physical Controls
Cash is easy to lose, so take steps to safeguard it. Storing cash in a safe is a good idea, but be sure to control access to the safe combination. There’s safety in numbers, so you should have more than one person present when cash from the safe is handled.
Bank deposits should be made regularly by the business owner or a trusted employee (or better yet, by two employees together).
It’s vital to secure unused checks. Keep them locked away in a desk or safe and allow access only to authorized check signers or preparers. Checks should be numbered so you can account for each check in the series. Voided checks should be defaced so they can’t be used again.
Controls for Cash Registers
When cash registers are used, the customer can see the price of each item and confirm the total. Electronic point-of-sale systems can also reduce mistakes and theft, as long as prices are entered correctly in the system.
When there are cash shortages or overages, be sure to identify who had responsibility for the register. Apart from concerns about theft, this may indicate a need for additional training or improved procedures.
When there are too many hands in the till, reconciling shortages or overages becomes very difficult. Therefore, many companies provide a new cash drawer at the beginning of each shift and have employees log into the register before use. Some businesses also use surprise cash counts to check whether employees are following internal controls.
Preparing Cash Flow Projections
There are many different types of budgets, including budgets for sales, cost of goods sold, and operating expenses. These budgets serve as the basis for a budgeted income statement, a balance sheet and—most important—the cash flow projections.
Cash flow projections are often confused with the income statement. The income statement may reflect the accrual basis of accounting, whereas cash flow projections reflect cash coming in and going out.
It’s also important to understand the difference between the cash flow statement (an accounting statement) and cash flow projections. The cash flow statement looks at past cash flows, while cash flow projections look at the future.
Timing of Collections and Payments
The first step in creating cash flow projections is to select a timeframe. In the example that follows, we’ll prepare a three-month (or one-quarter) projection.
See the example of a cash flow projection for Pat’s Machine Shop on the next page.
As you can see, Pat distinguishes between cash sales and sales on account. This reflects the delay between making a sale on account and collecting the cash.
Pat offers customers 2/10, net 30 terms: If customers pay within 10 days, they get a 2-percent discount. Otherwise, the full amount is due within 30 days.
What percentage of customers will pay in time to earn the discount? Pat estimates that 60 percent of sales are for cash, with the remaining 40 percent on account. The historical collection pattern for sales on account is as follows:
Customers paying within 10 days | 65%
Customers paying after 10 days but within 30 days | 5%
Customers paying after 30 days but before 60 days | 8%
Customers not paying at all | 2%
Historical patterns are often used to forecast cash collections. Any discounts allowed are subtracted from projected sales dollars, as are any bad debts expected. This determines the amount of expected cash collections.
Pat must also consider potential discounts in relation to accounts payable. The budget has a place for cash purchases and purchases on account. But in this example, all purchases used cash, so only one line is needed in the cash flow projection. If it’s significant, consider the timing of your payments and any discounts you expect to receive.
Operating Expenses
Your cash flow projections will usually include the same operating expenses shown on your operating expenses budget and your budgeted income statement. Depreciation expense is an exception. We include this on the budgeted income statement because we are trying to allocate the cost of long-lasting assets over time. However, depreciation expense has nothing to do with cash, so it doesn’t belong in the cash flow projections.
Owner Withdrawals
One aspect of cash flow projections that sole proprietorships and partnerships often miss is owner withdrawals. If you have other sources of support, it may be an acceptable budget assumption that you will not withdraw cash from the business. But if you need to withdraw cash for personal income, the cash flow projections worksheet should reflect this. Budgets have a way of coming true, so if you don’t budget any compensation for yourself, you might not get any! And if the owner of the business continually takes money out of the cash account without budgeting for it, serious cash flow problems are inevitable.
Borrowing and Cash Balances
The cash flow projections worksheet has a place to record anticipated new borrowing and debt payments. Note that in January, Pat plans to buy some new equipment. The purchase is a cash outflow, while the money borrowed from the bank is an inflow. This makes it easy to see whether the business will generate enough cash to repay its loans. (Don’t forget to budget for interest and principal payments.)
Pat has a negative cash balance projected for the end of March. Armed with this information, she can take steps to prevent the problem. Perhaps she will have to forego her withdrawal, postpone some purchases, or use her line of credit.
Consider your minimum cash balance requirements. Some businesses have a policy of not letting their bank accounts dip below a specified dollar amount. Others have a loan agreement that establishes minimum balance requirements. Look at the ending cash balance for each month, and consider whether your required cash balance will be maintained. If not, look for ways to bring additional cash into your business.
Assumptions
Remember: These are just estimates, and it’s OK to simplify your assumptions. If your business experiences very few bad debts, you might wish to ignore them in your forecasts. The important thing is to make sure your assumptions are reasonable and documented in writing. This is helpful when explaining your projections to outsiders—like bankers and investors—and it also helps you remember why you used a particular number. Later, you can check your assumptions against reality to see if you must alter them for future budgets.
Evaluating Alternatives
Cash flow projections are very useful when evaluating alternatives. This is especially true of projections made using a spreadsheet program. You might wonder, “What if we were able to increase our sales by 15 percent next year?” Adjust your sales and expenses accordingly, and put the new estimates in your cash flow projections worksheet to see the effect on your cash position.
…
As soon as Lucie and Ciro walked in the door, Al confronted them with the stack of overdue bills.
Ciro said, “I see you finally noticed our cash flow problem.” He explained that customer payments often came in long after the bills were past due. Sometimes, they were as much as 90 days late.
Meanwhile, Al often let people take their time to pay, without collecting a down payment. That meant he was burning through money for labor, rent and materials without collecting enough from his credit customers to cover his operating costs.
In the past, Ciro had always been able to keep bills from ending up in collections, but the cash flow problems had gotten a lot worse lately.
“Lately? Why didn’t you say something before now?” demanded Al.
“He’s said things to you over and over,” said Lucie. “But as soon as anyone talks about accounting and money, you just turn your ears off. You run out of the room the first chance you get.”
I wanted to argue with that, but I couldn’t. Lucie was right. I didn’t want to hear anything about books or accounting. I’m no good at the financial stuff. I never was.
The truth is, one of the things I hated about being a cab driver was having to make change. And it’s not because I’m bad at math. I wish it were that simple.
I think it’s something about the pressure of being on the spot. I just don’t trust myself to get it right the first time, and I guess that makes my brain freeze up. I don’t know what the exact reason is. All I know is, it’s never come naturally to me.
And that’s the whole reason I had Ciro doing it. If I were good at it and had the time, I’d do it myself. Instead, I hired a guy who has the skills I need, like any smart business owner would. So from my point of view, my attitude about accounting was not the issue. The issue was that we had a deal, and Ciro wasn’t holding up his end.
…
Managing Surplus Cash
Surplus cash is cash that is not needed for current obligations. Normally, businesses maintain a specific cash balance for daily operations and as a cushion against unforeseen expenses. If your cash balance exceeds this minimum, ask yourself these questions before investing those funds:
Is this a temporary surplus, or will this amount be continually available?
What financial requirements are coming and when? Income taxes? Employee bonuses? Balloon payments on debt?
How much of a risk are you willing to take with this money?
How much time are you willing to devote to managing this cash?
The first two questions address the issue of liquidity, which is the ability to convert an investment back into cash easily. Do you need an investment that allows you to withdraw the funds quickly?
Sometimes, you can predict when you will need cash. If you know you have a big tax bill to pay in March, you can choose an investment that expires by March or allows withdrawal at any time. The issue of liquidity is central to decisions like these.
Why Hold Cash?
Businesses hold cash for three basic reasons:
To meet current and planned expenses
As a precaution against unexpected expenses or a drop in revenues
To meet contract or regulatory requirements, such as compensating balances mandated by a loan agreement
The amount of cash you hold depends on your attitude about risk. How much of a chance are you willing to take that you won’t have enough cash to meet your obligations? How much cushioning does it take to make you comfortable? Remember, there’s always a tradeoff between risk and reward: If you keep an extra $10,000 in your bank account, just in case, you might be missing opportunities to use that cash to earn a substantial profit.
Investment Risk
The risks investors take include:
Default risk is the risk that the issuer will be unable to make interest or principal payments on schedule.
Liquidity risk is the risk that an investment can’t be sold at a reasonable price on short notice.
Return risk is the risk that the market price of the investment will go down.
There’s also a drawback to relatively low-risk investments. Reward and risk are inversely related, so investments with less risk will usually yield smaller returns.
…
Lucie’s loyalties were divided. She understood Ciro’s position. She knew that he’d tried to talk to Al, and that Al wouldn’t listen to him. She knew how much this upset Ciro, and she felt bad about it.
But she also felt that Al had a right to be upset. He hired Ciro to do the work so he wouldn’t have to. That was fair, wasn’t it? Shouldn’t Ciro have solved the problem himself? Maybe the problem was his inexperience.
Over a tense dinner, Ciro made a proposition. They’d make an appointment with a counselor at the local SBDC. That way, they could learn from an expert what they were doing wrong and how to fix it.
Al wasn’t happy about taking time away from work, but he also didn’t want any bad feelings in his house. Lucie and Ciro were his two favorite people in the world; if going to some boring meeting with a counselor would make them feel better, he was willing.
The counselor was a guy named Kevin. A nice guy, very no-nonsense. He listened to both sides. And he was polite about it, but he made it very clear I’d messed up in a big way.
That was a big surprise, and I wasn’t happy to hear it. But coming from someone outside the business, it was easier to accept.
He told me I had to get personally involved with the financial stuff, at least enough to understand it. Because the thing was, my business decisions depended on knowing how our cash flow stood at a given time.
My way of doing things was to say “I did two jobs today, so that’s $1,500.” If I needed to spend $1,000 a few days later, I just did it and tossed the receipt at Ciro.
But sometimes, the money I spent wasn’t actually there. Some jobs could take two weeks or more to finish. And sometimes I let people pay me in installments. I didn’t realize that a lot of times, any money that came in was already earmarked for a bill from last month or the month before.
I took two things away from that meeting. First, I felt guilty. I’d put Ciro in a really bad position and made his job a lot harder than it needed to be. Second, I felt hopeful because I saw that things didn’t have to be like that. My financial problems were bad, but we could fix them as long as I was willing to get involved and start doing things differently.
…
Investing Strategies
Your short-and long-term investing strategies will differ depending on whether your excess cash is temporary or permanent. Long-term investments include expanding your business or buying another one. Other chapters in this book discuss these options, so short-term investments will be discussed here. In all cases, you should consult your banker and investment counselor for advice.
Common investments include:
Interest-bearing accounts. Although these accounts may not yield the highest return on your investment, they are usually safe, liquid and easy to arrange. Money market accounts and other business accounts typically pay more interest than savings accounts.
Certificates of deposit (CDs) pay a slightly higher interest rate than a bank account, but you give up some liquidity. They are sold with a fixed term, and there is a penalty for early withdrawal. CDs may be appropriate when you have surplus cash for a known period of time.
Government securities. Treasury bills sold by the U.S. government have maturities of 91 days, 182 days or one year. However, there is a ready market for T-bills, so they can be sold with as little as one day remaining to maturity. The safety of this investment means the interest rates are relatively low. The federal government also issues Treasury bonds, which have maturities of three to five years. They are considered more risky than T-bills, and may be less appealing for a short-term investment. Last, many state and local governments issue bonds, which pay interest that is not subject to federal tax. Municipal bonds carry lower interest rates because of this advantage.
Commercial paper comprises unsecured short-term promissory notes issued by large corporations such as Ford Motor Credit Company. The maturity is usually 60 days or less, but the minimum investment can be very high. It’s not easy to sell commercial paper once you have it, so you should plan to hold it until maturity. Interest rates on commercial paper reflect the fact that the investment is unsecured. Accordingly, interest is higher than it is for T-bills.
Money market funds pool the resources of many investors to purchase short-term securities, such as T-bills, CDs and high-quality commercial paper. This allows investors to diversify their holdings without making multiple investments. Shares are liquid and easily obtained, often without a commission.
Mutual funds operate like money market funds, except that they invest in stocks, bonds or both. Some invest only in fairly safe securities, while others invest exclusively in a certain industry or in growing companies. Risks and rewards vary, and share prices are subject to market swings.
Socially responsible investing. Some businesses choose investments that will help the environment or give something back to the community. In addition to emotional and financial rewards, these investments may generate goodwill. Renewable energy is a popular area for investment, as is appropriate technology geared to the needs of the developing world (e.g., water purification technology or solar ovens). Microfinance—which makes startup capital available to disadvantaged entrepreneurs in the United States and the developing world—is another popular option, not least because microfinance loans have a very high rate of repayment.
…
Over the next few weeks, Kevin helped Al and Ciro analyze the business from top to bottom. They found a lot of areas for improvement. For instance, Al’s careless buying habits had kept him from taking advantage of bulk discounts, as well as discounts for paying bills early.
Al didn’t want to give up his flexible payment terms, but he did agree to charge a 50-percent down payment on all jobs of $100 or more, with the balance due when the car was picked up. He made a lot of little changes like that, and they had a positive effect on his cash flow.
When it came to getting involved with day-to-day financial management, Al was as good as his word.
I had to force myself at first. It was mostly about keeping my promise and not so much about the actual work. But the more I understood the books, the more interested I got. I liked knowing how the business was doing from day to day and month to month.
One day I was going over financial ratios with Ciro, and I said, “I get it now. It’s like when I was little, and my parents would stand me against the wall and mark how tall I was, so we could see how much I’d grown.” I was proud when I grew then, and I’m proud when my business grows now.
I thought if I took the time to get involved with the financial side of my business, my work would suffer. But the truth was the exact opposite. Facing the problem turned out to be way less stressful than running away from it. Once Ciro and I started working as a team, we had more money available and things went more smoothly. And that gave me more time to do better work and be a happier person. That’s a huge deal for my business, but it’s an even bigger deal for my family.
It proves what Kevin told us: Sometimes, a shortcut is the longest path to where you want to go.
…
Conclusion
If cash is the lifeblood of business, consider yourself the doctor. Give your business a checkup by doing cash flow projections, and prescribe ways to make it healthy by managing the cash flow cycle.
The importance of these procedures can’t be overemphasized. If you don’t pay attention to cash flow, the long-term prognosis for your business is poor.

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Pat’s Machine Company Accounts Receivable Aging Report January 30, 2018
Customer | Total Due | Under 30 | 30-60 | 61-90 | Over 90
Gravyhills, Inc. | $1,400 | $1,200 | $200
Amplex | $3,570 | $2,070 | $850 | $650
R. Totale | $2,090 |  |  |  | $2,090

Pat’s Machine Shop Bank Reconciliation March 31, 2018
Balance per bank statement | $3,500 | Balance per books | $2,900
Deposits in transit | 490 | Service charge | (15)
Outstanding checks | (1,075) | Error recording check | 30
Correct cash balance | $2,915 | Correct cash balance | $2,915

Cash sales
Handles central cash register | Person 1
Closes register and prepares cash report | Person 2
Prepares deposit slip | Person 1
Makes deposit and compares slip to cash report | Person 3
Checks received in the mail
Opens mail and makes a list of checks received | Person 4
Prepares deposit slip | Person 5
Updates accounts receivable records | Person 6
Compares the information from Persons 4, 5, and 6 | Person 7
Cash disbursements
Prepares checks | Person 8
Signs checks and reviews supporting documents | Person 9
Mails checks | Person 9 or 10
Bank reconciliation
Prepares bank reconciliation | Person 11
Reviews bank reconciliation | Person 12

Months | January | February | March | Qtr Subtotal
(A) Beginning Cash Balance | $25,000 | $12,840 | $2,469 | $25,000
Cash Receipts
Cash Sales | $30,000 | $31,800 | $36,600 | $98,400
Collect Accounts Receivable
Within discount period | $12,740 | $13,504 | $15,543 | $41,787
After discount period | $5,000 | $5,300 | $6,100 | $16,400
Collected in following month | $1,550 | $1,600 | $1,696 | $4,846
Sales of Fixed Assets
Miscellaneous Income
(B) Total Cash Receipts | $49,290 | $52,204 | $59,939 | $161,433
Cash Disbursements
Cash Purchases (Merchandise) | $12,450 | $12,900 | $14,850 | $40,200
Pay Accounts Payable
Labor Expenses | $38,695 | $38,695 | $38,695 | $116,085
Owner Withdrawals | $1,500 | $1,500 | $1,500 | $4,500
Non-Labor Expenses | $4,605 | $5,280 | $4,405 | $14,290
Purchase of Fixed Assets | $250,000 |  |  | $250,000
Debt Payment - Old
(C) Total Cash Disbursements | $307,250 | $58,375 | $59,450 | $425,075
Net Cash Flow (B-C) | ($257,960) | ($6,171) | $489 | ($263,642)
Adjustments to Cash Flow
(+)	New Debt | $200,000 |  |  | $200,000
(+)	New Owner Investment | $50,000 |  |  | $50,000
(-)	New Debt - Interest Payments | ($1,500) | ($1,500) | ($1,500) | ($4,500)
(-)	New Debt - Principal Payments | ($2,700) | ($2,700) | ($2,700) | ($8,100)
(-)	New Owner Withdrawals
(D) Adjusted Net Cash Flow | ($12,160) | ($10,371) | ($3,711) | ($26,242)
Ending Cash Balance (A + D) | $12,840 | $2,469 | ($1,242) | ($1,242)

| NxLeveL® TECH TIP BUSINESS RESOURCES AND THE WEB
Financial Analysis Tools The following tools can help you manage cash flow and produce cash flow projections: Pulse is an online cash flow management program designed for small businesses. It allows you to monitor and visualize cash flow daily, weekly or monthly. You can also organize your income and expenses by project. pulseapp.com Google Docs has a huge, searchable library of business templates at docs.google.com/templates. You can also upload and store your own templates. SCORE maintains a gallery of financial statement templates and spreadsheets at www.score.org/resources MathWiz is a versatile, easy-to-use financial calculator with spreadsheet-style input for cash flow analysis, amortization and loan repayment schedules. Functions include net present value (NPV), future value (FV), internal rate of return (IRR), payment amount, periods, and payback. www.informatik.com/math.html