For any business, cash is the fuel for growth. If you run out of cash, it’s not like Monopoly. You don’t get to pass Go; you don’t get to collect $200. The game is simply over. In my work as a business strategy consultant, I’ve seen companies that are doing exceptionally well for revenue be cash poor.

One such client is a manufacturer and distributor who was achieving revenue goals and thought they were doing well, including feeling like they were achieving profit. But something was very wrong. 

Allen Miltz, the author of Cash Flow Story, says that “revenue is vanity, profit is sanity, but cash flow is king”. This company fell into this trap: they were happy with their revenue and they were doing okay with profit. But they were paying no attention to cash flow. They succumbed to multiple deadly sins of cash flow management, and it almost killed their business.

Who Is Accountable for Cash Flow Management?

Cash flow should be monitored and managed just as thoroughly as any other metric. When you’re looking at your sales pipeline to ensure revenue is coming in, you need to manage your cash flow forecast to ensure you always have enough cash to pay the bills.

Strangely, this is one report I rarely see from accountants when we’re doing financial dashboards. Profit and loss, balance sheets, and other types of statements are always readily available. But rarely do I see a cash flow forecast.

Usually, they’re managing cash by looking at a bank balance. The problem with that is that a bank balance tells you nothing about the bills that are coming next month! Every business, once it gets out of the entrepreneurial stage, should be looking at some sort of a cash flow forecast monthly to make sure it always has the fuel to live and grow.

The 7 Deadly Sins of Cash Flow Management

Let’s look at some of the most common mistakes that businesses (including the one in our example) make when it comes to cash flow.

1. Not managing accounts receivable

Problem: This business was acting as a bank for its customers. People would buy from them and then not pay them for months on end. The standard accounts receivable metric is Days Sales Outstanding (DSO), calculated by dividing average accounts receivable by net credit sales and multiplying by the number of days.

For this business, days outstanding were in the hundreds. Somewhere between 30-40% of their revenue was sitting in accounts receivable at any time. That’s cash not in their pockets, so they weren’t able to pay suppliers or do other things with it.

Solution: Active management of accounts receivable. When we worked with them, the first thing we put in place was to have a team member send out statements and then start calling people to remind them to pay. Today their AR days metric is where they want it to be, which has injected more than 1 million dollars in cash flow back into the business.

2. Not paying attention to inventory

Problem: Inventory levels don’t generally show up on the profit and loss since it’s a balance sheet item. The business didn’t realize how much inventory could affect cash flow. They got good deals on large batches of inventory deals but didn’t pay attention to the metrics. They ended up with two warehouses full of millions of dollars’ worth of aging inventory.  

Not only did they have a massive inventory, but they were also paying for two warehouse spaces that were costing them dearly. They never looked back at SKUs to figure out the worst performing and decide whether it made sense to maintain those as inventory. 

Solution: You need to maintain a balance between the right amount of inventory and buying/building it most cost-effectively. Do this by strategically looking at inventory and figuring out how much to maintain based on lean times to maximize inventory turns. 

This business did lots of calculations and forecasting and got smarter about purchasing. Today they have one small warehouse with just enough inventory to be able to handle their turns and lead time, plus a safety margin. They no longer produce their bottom handful of SKUs and are bleeding off that inventory. This took time but is yielding a huge increase in cash flow.

3. Not optimizing accounts payable terms

Problem: When we started working with them, this company paid cash upfront for everything they purchased. They have a long cash conversion cycle because much of their production is happening offshore and needs to be shipped and then sold based on seasonality. That means they were putting up cash up front that sometimes they wouldn’t see back in 9 months.

They were exceptional at paying their accounts the day the bill came in (which is great as one of their service providers!), but when you’re optimizing cash flow, you want to get the best terms you can.

Solution: You only want to pay what you must pay so you can maximize your cash conversion cycle. This means getting creative and negotiating. That may mean buying a certain volume so you can negotiate better terms or getting a discount if you pay sooner. Another option is negotiating longer payment terms (Net 60 or Net 90) with low interest which makes it worth stretching the payment.

4. Not having a relationship with your bank

Problem: Every business should have a relationship with the commercial lending team at their bank. There are going to be times when cash flow is tight. Sometimes it makes sense to leverage your banking relationship in a loan that helps you grow your business. If you haven’t built up credit and a relationship, the opportunity won’t be there when you need it. 

In uncertain financial times, this sin becomes a deadly sin. When something like the COVID-19 pandemic happens and your sales dry up, what do you fall back on? This company didn’t have a company credit card and had never taken a loan or even spoken to a commercial banking manager. All they had was a couple of bank accounts.

Solution: They got company credit cards and started with a small line of credit to build up their rating. Today, they have a reasonable line of credit that could provide a safety net for a couple of months of basic expenses if they ever needed it.

5. Not having a cash contingency fund

Problem: One of my questions to new consultants, as they’re building their practice, is how long their runway is. In the worst case, if revenue dries up, how many months can you survive? The same thing applies to businesses. 

Solution: A business should always have a contingency plan and an appropriate amount of cash sitting somewhere secure to ensure that it can survive. How much depends on their cycles and expenses. But you need at least a few months’ worth. The last thing you want is to have to lay off your team because a big deal didn’t materialize. 

The business in our story now has a comfortable 6 to 8 months of cash sitting in cashable investments plus their line of credit so they can survive a year with minimal revenue. 

6. Not managing your margins 

Problem: It’s great to get a high revenue, but it’s a problem when you’re not tracking the gross margins on it. This client started selling to OEMs, which buy a massive volume but at a discount. They got a deal worth a million dollars and were super excited. But the margin on that deal was pathetically small because the OEM was very aggressive. The margin was so low that it was less than selling a small percentage of what they sell direct through their website. 

Solution: For sales of any type, you need to understand not just what the revenue is but also the potential margin on the deal. It’s vital to manage the gross margin contribution from every product you have and ensure that deals are done at the right gross margin levels to make it worthwhile for the business. 

This business restructured its chart of accounts to ensure all direct costs were put into the cost of goods sold. They figured out the gross margin on each product and started setting and managing goals related to these. They discovered their pricing was out of date, so they were able to update it in a way that made their margins healthy while keeping their customers happy.

7. Not keeping an eye on overhead

Problem: It’s all too easy for overhead costs to slip under the radar without anyone paying attention to whether the business is getting value out of them. Overhead costs are those that aren’t directly related to the products or services you’re selling. 

This includes things like SaaS subscriptions, office space, marketing, IT, and phone system contracts. When you don’t pay attention or review line items regularly, they tend to expand to fill up the maximum space available.

Solution: Someone needs to pay attention to overhead costs, adequately budget for them, and monitor them. This company didn’t even realize some of the things they were paying for until they went through line by line to figure out what they weren’t using. Their accountant was able to make some changes to save them thousands of dollars a month in overhead.

As you can see, with plenty of hard work and discipline, a company can get financially healthy. Today, the profit margin of our example company is great. More importantly, they have the cash flow they need to handle changes in the sales cycle comfortably and invest cash into bigger strategic directions. Want to know more? Get in touch.