While the primary objective for most small businesses is to make as much money as possible, just because you’re busy and seem to be pulling in a profit doesn’t mean you’re headed in the right direction. “A rapid accumulation of cash can be a sign that a business is performing well," says Patrick Byrne, CEO of Balboa Capital. "However, it can also signal that a company is under-investing in its future.
“Sitting on cash reserves and not making the necessary investments in your company can inhibit its growth and success in the long term," Byrne says. "You can have a ‘cash cow’ now, but if you don’t invest those profits back into the business, you may find that increased competition, changes in customer expectations and economic cycles turn your cash cow into a sunken ship.”
Dave Kurrasch, vice president and general manager of Small Business Payments Company, agrees with that line of thought. You might have a problem if you don't use positive cash flow to exploit market, expansion and product opportunities, he says.
“Firms can be very successful in the short run, and profits and cash flow can be very rewarding to owners and shareholders," Kurrasch says, "but if a company relies on products and services that are gradually becoming irrelevant or unpopular, the business will certainly face a crisis at some time in the future.”
Signs You're Headed in the Wrong Direction
Having plenty of cash looks great on your balance sheet and offers protection during difficult times, but when a company is growing too rapidly and making outsized profits, it can experience financial and other operational problems, including mismanaged profits and uncontrolled growth. Some of the warning signs:
- Decreased productivity due to long hours and low employee morale
- Failure to properly train new employees or plan for succession in management
- Hiring too many employees without a firm plan for their function or placement within the company
- Diminished quality of products and/or services
- Trouble with inventory management
- Increase in customer complaints
- Business owner(s) assuming responsibility for an overabundance of daily operational functions, causing a loss in focus of the company’s core objectives and growth goals
- Cash-rich mindset that leads to spending based on impulse rather than long-term planning, such as moving into expensive offices or overspending on office equipment and technology
Backed by a solid plan, however, you can take advantage of the profitable times when they come. Doing so requires that you manage your cash flow and continue to proactively improve upon your products and services.
“Having the right systems in place to effectively manage cash flow can help business owners make investments based on sound financial evaluation,” Byrne says. “A positive cash flow keeps a small business moving forward and helps it weather unexpected slow sales periods. It also prepares small-business owners for success when seeking additional capital for opportunities like expansion initiatives and equipment acquisition.”
Effectively Managing Your Money
Effective cash flow management begins with analyzing future cash flow requirements in order to predict potential trouble ahead of time, Kurrasch says: “All companies, and in particular small businesses, should create a rigorous cash forecast that looks out three to six months at a minimum, if not longer. This is particularly true for very capital-intensive businesses that must continually invest in inventory, plant and equipment.”
Strong strategies for improving cash flow, according to Byrne, include:
- reviewing sales and expenses daily
- sending invoices on time
- paying bills promptly
- creating sales forecasts
- reducing expenses
- continually investing in the company
“Rather than taking out every dollar earned by the business in the form of a salary or dividend, you must balance your own cash needs with those that will maximize the long-term success of your business,” Byrne says.
Read more articles on cash flow.
This article originally ran on October 7, 2014.