The following scenario plays out every day on Main Street:
“My business is really growing these days,” a small business owner confides to his friend, “but we’re still experiencing too much negative cash.”
And then, with that deer-in-the-headlights look on his face, he completes his concern, “I thought by now, with sales and profits up, cash flow would be the least of my worries. I used to be afraid I couldn’t grow my business; now I’m worried that’ll collapse.”
Beware Blasingame’s 2nd Law of Small Business: It’s redundant to say, “undercapitalized small business.” This maxim is especially true for growing small companies because sales volume growth depletes cash in two dramatic but predictable ways.
1. When the business is growing, organizational upgrades are to be expected in order to handle the new demands: new vehicles, staff, technology, etc. Of course, you must fund these things, often before the newfound success has made it to the bank.
2. Selling to customers on an open account—where payment for work or products is collected after delivery—is essentially making loans to customers. And while it’s true that vendors may let you do the same, typically they allow less time to pay than you allow your customers. The difference between when you pay and when you collect creates a negative cash condition.
Here’s how to manage these challenges.
1. Growth plans must be compatible with the ability to fund that growth.
Too often we think the big growth hurdle is getting customers to say yes. But the impact of sales growth on cash flow must consider before delivering a proposal. If you can’t fund the opportunity, you shouldn’t go after it.
2. Don’t use operating cash to fund acquisition of capital assets, like equipment, etc.
Capital purchases should probably be funded by bank debt, and the interest is the cost of Blasingame’s 2nd Law. If you don’t like debt or paying interest, that should motivate you to leave profits in the business as retained earnings, which is the best way to overcome being undercapitalized.
3. Monitor the relationship between AR & AP.
Understanding the relationship between Accounts Receivable Days and Accounts Payable Days is an “a-ha” moment for every business owner. This ratio must be monitored for sustainable growth.
Write this on a rock … It is possible to succeed yourself out of business.