Cash is King – The Value of Cash Flow
For any small business operation, getting cash into the bank account is critical to survival. Without cash, the probability of success dissipates quickly. How do you get cash into the bank account? There are several sources of cash: they include capital, loans and customer payments.
When the business operation starts the owners or family puts up the cash to begin the operation of the business. Usually capital is used to organize the company, set up office operations, and provide for temporary funding during the initial period of growth e.g. payroll, rent, utilities, general operating expenses. In addition, capital is used to make deposits and provide the down payments on large cost assets such as equipment and vehicles.
Loans are obtained to pay the balance of the large ticket items. This most often is never seen in the account as financing arrangements are created to pay for the large ticket items. There are two types of loans, secured and unsecured. Banks will rarely issue unsecured loans except to their best customers and even then, the bank uses some form of a wraparound security agreement to have access to collateral in case of default.
Finally and most importantly is the cash received from operations or more commonly referred to as the customer. Now those operations that receive their cash upfront have an advantage in start-up over most other types of operations. Examples include restaurants, hair salons, retail outlets and automotive maintenance. Here the customer pays for the product or service upon departure. Therefore the owner rarely if ever carries a receivable on the books. This decreases the initial cash in the form of capital to cover initial operations. For those that have to carry receivables such as maintenance companies, professional services, and contractors, you have to deal with collecting this money.
Collecting money costs money! The biggest expense is nonpayment of the bill. The next biggest is the carrying cost of the money. Some small business operations utilize lines of credit to cover the time period of carrying the receivable on the books. Additional costs include having staff to collect receivables, incurring time and costs associated with processing statements and documentation of receivables. All of these add up to less money in the bank account.
If starting out in business, consider the above cash sources. It is better to be in the high cash operating system (where the customer pays immediately after product/service purchase) over the deferred receivables format. Once established, the business can slowly convert to the receivable format where margins should be higher and greater profit is generated over time. If no other choice than the traditional deferred system, then make sure initial capital is enough to sustain operations for the collection cycle. Remember the most common reason for business failure is the lack of capital at the onset of the business. Act on Knowledge.
© 2012 – 2022, David J Hoare MSA. All rights reserved.