May 2008

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How to manage cash flow in your business

May, 2008

Your business needs cash to survive. Manage cash well, and your company can sustain growth into a profitable future. Neglect it, and your firm may soon be selling inventory on the auction block.

Cash flow is the movement of currency, bank drafts, and other sources of short term funds into and out of a business. It's not the same as profit. On paper, your firm may be a model of profitability. Over time, revenues may exceed expenses. But if the firm fails to maintain adequate "liquidity" (having sufficient cash on hand to cover short-term needs), a profitable firm can spiral toward bankruptcy in a matter of weeks.

For many businesses, reducing the lag time between buying inventory and receiving customer payments is the single biggest factor in effectively managing cash flows. Others are more concerned with saving for future cash needs. Like farmers who purchase seed and plant a crop well before harvest, some firms pump out a truckload of cash up front in anticipation of future revenues.

No matter the type of company you're managing, following a few simple practices can be the key to effective cash flow management.

Reduce lag time. For example, give incentive discounts to customers who pay early. Aim for just-in-time inventory to reduce holding costs.

Establish a line of credit. To cover shortfalls resulting from excessive lag time, unforeseen business disruptions, or weakening in your particular market, set up a line of credit with your local financial institution. But take care that short-term credit doesn't develop into a crutch that props up poor cash management.

Check out new customers. Like a landlord who checks the payment history of a potential tenant, a prudent business owner will assess whether new clients are likely to pay on time — before extending them credit. Deadbeat clients can squeeze a firm's cash flow quickly, especially if they purchase large amounts of inventory or services.

Grow with caution. Expanding into new markets can bring momentum and additional sources of income. But watch out. Developing new product lines, expanding facilities, hiring employees, ramping up your marketing budget — all consume cash. Before racing down this road, be sure to generate accurate cash forecasts, preferably with expert help.

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