Cash Flow: The Number That Keeps You Alive

A business can be profitable on every page of its accounts and still not make salary payments in March. This surprises people the first time it happens to them and it is the single most common way an otherwise healthy small business dies.

Profit is an opinion about a period. Cash is a fact about a Tuesday. Only one of them pays anybody.

Where the gap comes from

The gap opens because the money leaves before it arrives. You buy stock in January, deliver in February, invoice at the end of February and get paid in April on sixty-day terms. The books show a profitable February. The bank shows three months of outflow with nothing coming in.

• Growth widens the gap. A doubling order book doubles the money you must spend before you are paid.
• Stock is cash you have decided to store as objects and objects do not pay salaries.
• Receivables are revenue you have already reported and not yet received.
• Tax and statutory dues are due on their date, not on the date your customer chooses to pay.

The four numbers to know from memory

• Cash in the bank today, not the sanctioned limit and not the receivables.
• Fixed monthly outflow: salaries, rent, dues, the things that leave whether or not you sell anything.
• Runway: the first divided by the second, in months. Under three is a warning, under one is an emergency.
• Average days to be paid, measured from invoice date to money received. Most owners guess this low by two weeks.

If those four are not on one page you can look at in ten seconds, the business is being run on a feeling. Feelings are fine for judgement calls and useless for solvency.

How to widen the runway

• Invoice the day the work is done, not at month end. This one change is worth days of runway and costs nothing.
• Take an advance. Even twenty-five per cent shifts the whole cycle in your favour.
• Make the terms explicit and follow up on day one of overdue, politely and without exception.
• Buy stock against orders wherever the business allows it, not against optimism.
• Arrange credit before you need it. Facilities are cheap to hold and expensive to seek in a crisis.

Say no to the order that would kill you

Sooner or later a large order arrives with long payment terms and a cash requirement bigger than the runway. It looks like the making of the company. Taken without the working capital to survive it, it is the end of the company and the accounts will show a profit right up to the week the salaries do not go out.

Turning that order down, or restructuring its terms until it is survivable, is not timidity. It is the whole job.