Here’s an interesting puzzler. How is it possible for a profitable business to be growing and failing at the same time? The all-important answer to this conundrum lies in the company’s cash flow.
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Hot product companies that experience rapid sales growth have to purchase and assemble inventory months in advance of shipment to retailers and distribution partners. This eats up a company’s cash. And just when customers get around to paying for past product shipments, the company has to invest its available cash in the next inventory production run. Fast-growing companies also pay out higher sales, taxes and insurance bills too. This is how too much success can quickly lead to an empty bank account.
Sadly, if a commercial bank doesn’t step in to help a company catch up, the company may have to lay off workers, cut back production or face bankruptcy. This scenario is the living nightmare of American business today.
Here are six easy ways to protect your company’s precious cash life line.
No. 1: Respect cash flow forecasting. When entrepreneurs come up with a new product or service idea, it is customary for them to estimate the size of the customer market, check out competitors and design the final product in such a way to maximize profitability and customer appeal. Smarter entrepreneurs consider the timing of cash needs in their planning too. If the balance of incoming and outgoing cash is too tight, they have time to alter their plans to avoid a cash flow crisis.
No. 2: Limit exposure to high-risk customers. Are your largest customers also your company’s slowest paying customers? If so, take immediate steps to diversify the customer mix to favor faster paying customers. Sales commission payments should be tied to the timing of customer collections too.
No. 3: Bill frequently. Most service-oriented businesses bill on a monthly basis or at the end of a project. Why not bill customers every week or every two weeks in the form of progress payments? The faster companies invoice customers, the faster they get paid.
No. 4: Reduce dependence on a single funding source. As too many entrepreneurs have learned, it’s relatively easy for banks to pull credit lines when companies can least afford it. To minimize the risks of sudden cash shortfalls, smart entrepreneurs set aside one or two credit cards for emergencies. More established companies maintain relationships with multiple banks and take every opportunity to network to credit officers from big and small banks.
The first time a lending officer learns about your company should not be the day you are desperate for cash. If you don’t know the names of at least four bank credit officers, ask your business colleagues for referrals now!
No. 5: Streamline product lines. Entrepreneurs who don’t have a lot of loose cash should avoid producing too many products in too many styles to sell to too many different types of customers. The more complex a company’s product line, the more cash that is required to produce, store, advertise and deliver goods to customers.
No. 6: Set high profitability standards. The companies that are most vulnerable to financial heartaches during a recession or credit crisis are low profit margin businesses. Simply stated, low margin businesses have no margin for error. Don’t be shy about axing products or services that don’t match or exceed your industry’s average profit margins.
There is another reward for entrepreneurs who emphasize cautious cash management in their day- to-day business operations. Lenders and investors want to work with them.
Susan Schreter is a 20-year veteran of the venture finance community and a university educator in entrepreneurship. Her work is dedicated to improving startup longevity and operating performance in rural, urban and suburban America. She is the founder of www.takecommand.org, a community service organization that offers the largest centralized database of startup and small business funding sources in the U.S. Follow Susan on Twitter @TakeCommand.