When it comes to running a business, money is everything. For small business owners, money means cash. Most small businesses don’t have a lot of reserves to fall back on—if clients fail to pay their bills in a timely manner, or if hidden expenses sneak up, then liquid assets dry up and all of the sudden you’re juggling expenses just to keep the lights on.
The key to ensuring that this never happens is to have clear visibility into the health of your cash flow. At a high level, this should be simple—keep track of how much money you have coming in, keep tabs on your expenses, and make sure the latter never surpasses the former.
Reality is never so simple. A lot goes into calculating where your cash position stands at any given moment. Markets ebb and flow, operating costs can be unpredictable and uneven—any number of things can muddy your understanding of how much wiggle room you have to work with. That’s why analysis that provides a crystal-clear view of cash position is crucial for small business owners.
You need to be able to see the full path that cash is taking in and out of your business, and be able to dig into it at any time you need to make an operational shift in your business.
These three steps will guide your analysis and help you maintain control of your financial future.
1. Review Trends in Where Cash is Coming From
You learn a lot by identifying trends in when cash is coming in, but it takes some work to get truly useful insights. It’s not enough to simply know how much cash is coming in one month compared to another—you have to take another step to see what your most consistent source of income is over time, and ensure that you always receive the full amount of cash owed to you.
Obviously, this analysis will be much simpler for some businesses than for others—it’s much easier to track cash flow for a taco truck than for a software company—but in both cases business owners need to know exactly where they stand. Specifically, the questions you should be able to answer are:
1. Which customers have the largest outstanding invoices?
2. Are customers paying on time?
3. How long does it take us to collect?
These are the critical questions when it comes to managing your cash because they are all areas where you can take immediate action. Segmenting the amount of money that is owed to you and knowing the likelihood you will be able to collect on each invoice serves two purposes.
The first is that it allows you to target your collection efforts. You shouldn’t spend resources chasing $400 that is 20 days overdue when you have an invoice out for $5000 that is 60 days overdue.
The second result of this analysis is that you can make more accurate predictions about how much cash you will have on hand in the future, and you have the information you need to make forward-looking business decisions as a result.
2. Identify Where Your Costs are Increasing
Cash coming in to your business is one side of the coin—cash going out is the other. It’s easy enough to see your total operating expenses on a month by month basis, but you need to have a more a granular understanding of how your money is being spent if you want to stay in the black.
This may involve a lot of hours spent digging through individual line items on the balance sheet and income statements, but the only way you can make informed decisions about how to reduce your operational costs is to have full visibility into where your money is being allocated.
Unfortunately, the reality is that many small businesses don’t have any good way to dig into where their money is being spent. Every business owner should be able to answer these questions:
1. Where is my money going?
2. Am I forgetting any irregular expenses?
3. How long can I stay in business if the income stops?
Once you have a complete record of the cash you owe, you can make accurate, data-driven decisions about whether you can invest more to expand the business or if you need to tighten your belt and cut costs.
3. Keep a Close Eye on Your Days-Cash-on-Hand
There’s no magic formula that will tell you exactly how much cash your business needs to keep on hand at any given moment to be prepared for a rainy day, but keeping track of Days-Cash-on-Hand will give you a good estimate.
Days-Cash-on-Hand is loosely defined as the amount of unrestricted cash and liquid assets that a business has available on any given day. The metric is designed to be a benchmark to help you budget and plan operational expenses.
Effectively, Days-Cash-on-Hand acts as a gas meter for your business—it tells you how far you can travel before you have to refill.
Again, this metric is more pertinent for some industries than for others, but when combined with detailed information about how cash is coming into and leaving your business, it serves as an excellent benchmark for the financial health of your business, and empowers you to be confident with the financial decisions you make.