Getting the cash to flow your way – suggestions to improve cash flow in a small business: includes a glossary

Getting the cash to flow your way – suggestions to improve cash flow in a small business: includes a glossary – Business Management

Deidra Ann Parrish

Maintaining a positive cash flow means preparing the right financial statements. Here’s some tips on keeping you books and your business in the black.

EVERY YEAR, THOUSANDS OF BUSINESSES ARE launched. But no matter what their specialty or locale, the Small Business Administration reports that about half will fail within the first four years, too often because of mismanagement of finances. The problem typically has less to do with intellect or commitment than lack of experience. After all, many ambitious entrepreneurs have hung out their business shingles without so much as a primer course in business accounting. But proper financial management is as important to a business’ survival as sales, profits and innovation. “There are lots of unexpected situations that can pop up and surprise even a skilled business person,” says Eddison Bramble, president of Ultimate U Health and Fitness Center in Hempstead, New York. “So if you’re lacking basic accounting knowledge, running a business is going to be that much more challenging.”

Bramble owned three businesses before opening the fitness center and admits that his current business operates more efficiently because of some of the lessons he’s learned along the way, such as preparing and maintaining accurate financial statements.

These documents, which include balance sheets, income statements and cash flow analyses, are like your company’s diary. They reveal the way business is conducted, where the profit centers are and where potential financial land mines are festering.

Bramble was close to experiencing financial loss while heading a business services company that provided pager service, among other things. But he didn’t fully realize the return on the cost of providing the service. “We were making sales, money was coming in and I thought cash flow was appropriate. But when we finished paying our expenses on the beepers, we realized we were giving the service away,” says Bramble, who was able to catch the oversight and save his business from financial ruin.

Overlooking potential accounting problems can send your business on a fast downward spiral. Such things as overdue receivables and cash flow shortages can prevent you from ordering new inventory and paying employees. So understanding generally accepted accounting principles (GAAP), then accurately applying and documenting them is important.


In business, your goal is to make money. In business accounting, your goal is to compile a financial statement that keeps track of it all. You may think you only need to keep track of day-to-day activities in order to measure profits, but there’s no way to accurately track all the money flowing in and out of your business in your head.

Money is best tracked in a financial statement, a report that contains all the information you and an accountant or banker need to assess your company’s financial health. It’s prepared in a prescribed format, including a balance sheet, income statement, statement of cash flows and a statement of retained earnings. Many business owners delegate the compilation and maintenance of this information to accountants–and that’s fine. In fact, it’s recommended if you can afford it. But that doesn’t absolve you of the responsibility to understand what these documents mean to the health of your business.

Marjorie Waugh, a CPA in Seaford, New York, cautions business owners against turning over 100% of the accounting responsibility to a third party. “I advise my clients to get involved with their financial management,” says Waugh. After all, making decisions about which areas to scale back, when to hire new people and which new ventures to pursue is still your job and you can’t do it effectively unless you have an accurate reading of your company’s financial well-being.


The first document in the financial statement is the balance sheet. Lenders and business appraisers look at the balance sheet to see how much your business is worth and how easily it can be liquidated in the event a debt falls into arrears. By definition, it’s a snapshot of your company’s financial position at a particular point in time. It shows what you have (assets) versus what you owe (liabilities), and ultimately, your equity in the business or net worth. Understanding what items qualify as assets or liabilities is sometimes tricky. Assets are typically broken into “current” and “noncurrent.” Both list items that are cash or will be converted into cash. Current assets can be converted to cash within 12 months, and noncurrent assets, beyond 12 months. Current assets include accounts receivable, inventory and prepaid expenses. Noncurrent assets include utility deposits, deferred income taxes, property and equipment, less depreciation costs.

Just like with assets, liabilities are listed as “current” and “noncurrent.” The difference is that many liabilities fit both categories. If, for example, you took out a $150,000 loan, payable over 10 years, the entire debt is not counted as a current liability. Ten percent–or $15,000 plus interest–is listed as a current liability on each year’s balance sheet, leaving the remainder as a future or noncurrent liability. Some current liabilities include payroll taxes, accrued expenses, deferred income and accounts payable.

Once you have calculated your assets and liabilities, subtracting the latter from the former reveals the owner’s equity, net worth or net assets. Keep in mind these terms are used interchangeably and can also be applied to one’s personal finances. For example, if you have a home worth $185,000, a car worth $15,000 and cash and investments worth $35,000, what is your net worth? If you say $235,000, your math is right but your answer is wrong. Before calculating your net worth, you have to deduct liabilities, such as the balances on the mortgage and car loan, $98,000. That brings your net worth to $137,000. In other words, if you liquidated your assets and paid your debts, that’s how much you should have left. Remember, the value of a firm in liquidation will not necessarily equate to your exact net worth.


Naturally you want positive rather than negative net assets. However, many young companies start off at a loss because they don’t build enough equity up front. Create a positive net worth from the beginning. This will prevent a negative equity situation from persisting as the company grows.

Accounts receivable are directly connected to debt and equity. If you don’t have money coming in, you’ll have to burrow, thereby increasing your debt to stay afloat. For that reason, monitoring receivables is high on Charles H. James III’s list of things to watch. James is president and CEO of C.H. James and Sons Holdings Inc., (No. 73 on the BE INDUSTRIAL/SERVICE 100 list), a $30 million food processing, wholesale food distributor in the City of Industry, California. “You want to collect your receivables and turn your inventories as fast as possible and pay your payables as slowly as possible without incurring any penalties.”

Establish terms for your receivables and hold all your accounts to those terms. This way, you can establish cash flow expectations and be mindful of the amount of money due to be collected within a given time frame. From there, you can plan future spending, investing or borrowing. Although it varies by industry, the average days payable is 30-60 days.

Henry Holly, founder and president of Hempstead Transportation Service, a 32-year-old family-owned business in Hempstead, New York, admits in the earlier years, “We didn’t keep a close eye on receivables [because] we were so busy trying to get business and handle what we had that we would lose track of what was due.” In addition, Holly says, many African American business owners have a familial mode of operation, where handshakes seal deals and it’s not unusual for payment terms to be extended almost indefinitely. “Doing business that way will cripple you,” warns Waugh. “If you’re not collecting the money that’s due to you, there’s no way you’re going to survive.”

To shorten your days payable, put payment terms in writing on all sales contracts. Make sure customers have their own copy. Consider attaching late fees to encourage receiving payments on time. And be prepared to contact debtors and follow through when payments are overdue.


Another trouble spot for entrepreneurs is inventory–how much to order and when to order. Depending on the type of business, a large portion of a company’s assets can get tied up in inventory, impacting cash flow and ultimately slowing down profitability. Your goal should be to design policies that achieve optimal investment in inventory. You accomplish this by determining the optimal level of inventory necessary to minimize inventory-related costs. Unfortunately, this is hard to do unless you’ve been in business long enough and have had enough steady activity tO establish sales trends.

Some accountants prescribe the economic order quantity (EOQ) method to determine ideal inventory. It determines the order size that minimizes the sum of your carrying and ordering costs. But calculating an EOQ involves a complicated algebraic equation. There’s also the inventory turnover equation, which helps you determine whether you’re carrying the right level of inventory. Generally speaking, the inventory turnover equation equals the cost of goods sold divided by inventory. This formula tells you how many times in a year you are turning over, or selling, inventory. Here, higher numbers are better because they mean you’re moving merchandise quickly. Conversely, if your numbers are low, you may be carrying too much inventory. What’s considered high or low varies from industry to industry. James, for example, says his average turnover is seven days, but that’s because his inventory is perishable. You should consult an accountant to learn the average rate in your market.

Formulas aside, Stu Wallace, a principal with Anderson, Facka and Wallace, an accounting firm in Richmond, Virginia, suggests watching inventory levels on a quarterly basis. Bramble agrees: “Be conservative with your inventory up front while you get to know your business. By watching my business over the years, I can tell you how well I will do on an average Monday night versus a Wednesday night.”


The balance sheet is an important part of your financial picture, but it’s only one piece. It doesn’t tell you about income from sales, cost of expenses or profit. That’s the job of the income statement. It lists revenues and expenses to show you the company’s bottom line: net income or net profit. Many accountants suggest the most useful way to arrange your income statement is in a comparative format, in which you show the most current year s activity side by side with the previous year.

The income statement is multifaceted, so for the sake of keeping this interesting, let’s use an imaginary company, Troy s Computer Supply Center, to illustrate the variables. Troy’s income statement first lists his net sales for the year–let’s say they’re $300,000. From that, Troy subtracts the cost of goods sold, $160,000 (what he paid for his computer products). He’s left with a $140,000 gross profit.

For more clarity on how each group in your company is faring, break OUt gross profits for each unit: product sales, service contracts, consultation, etc. This way, each division’s performance stands on its own and it’s easier to identify strengths and weaknesses.

Next, the income statement covers net operating income. It’s attained by calculating the sum of your selling and administrative expenses and subtracting them from your gross profit. Selling expenses include the salary for Troy’s one salesperson and costs for marketing and advertising. We’ll put Troy’s selling expenses at $44,000. His administrative expenses include costs for administrative salaries, rent, employee benefits, payroll taxes, insurance, utilities, office supplies and equipment depreciation. That total is $53,000. The sum of the two is $97,000, which gets subtracted from the gross profit, for a net operating income of $43,000.

The last bit of arithmetic covers interest income and interest expense. “The costs will be in direct proportion with the amount of debt you carry,” says Wallace. Subtracting them gives you the by-product of the income statement, net income/profit. Here again, you want positive numbers. If you were operating in the red, it would show up here as a loss.

In layman’s terms, after all related expenses, before taxes, Troy has earned a $34,400 net profit over the course of the year. “Just because it seems you’ve made profit on paper doesn’t mean you’ve made money in the bank,” says James. “Often, sales are made on credit, which means your net income counts money that hasn’t truly been collected.” That’s worth noting because you don’t want to spend money you don’t have.


Based on the information from your balance sheet and income statement, an accountant can prepare a statement of cash flows for your company. It shows the sources and use of cash, for example, net borrowing under credit agreements, cash used in investing activities, proceeds from long-term debt and dividends paid. It’s a no-brainer that tracking the flow of cash in and out of the business is fundamental to the big picture. But Waugh and Wallace agree that unless you are adept with accounting terms and practices, arranging a statement of cash flows is an area better left to your CPA. Instead James and Waugh offer some useful tips on other areas to watch.

Industry averages: If you didn’t research them before opening shop, d”`yourself a favor and find out what the business norms are in your industry. “Every industry has different averages on things like collection of receivables, payment terms on loans and duration of sales cycles. These variables directly affect your cash flow and your ability to satisfy debt,” says James. Getting a handle on them can help you be prepared to ride the highs and lows.

Establish a budget: Never mind keeping a running tab in your head. You need to put pen to paper and make a plan. Waugh’s prescription? “Establish goals, compare your results against your goals and revise your goal as you go along.” This activity, she says, should be ongoing.

Despite what high-priced accountants may say, accounting is an unscientific practice. It looks at historical trends in your business and by using GAAP formulas, offers educated estimates on your financial fortitude. It’s all you have to help you weather the storms of the business world, so why not arm yourself with as much protection as possible? That doesn’t mean you should go out and enroll in the Harvard Business School, but you must take part on some level.

“I’m no accountant,” says Bramble. “But I have a good understanding of what it takes to run my company.”

COPYRIGHT 1997 Earl G. Graves Publishing Co., Inc.

COPYRIGHT 2004 Gale Group