Sandra Taylor-Sawyer: Everybody’s Business
Having a profitable business means success — myth or fact?
Before answering the question, it is important to understand the difference between cash flow and profitability.
The leading cause of business failure is improper cash flow planning. In order to plan cash flow, a general understanding of accounting principals is needed, according to the U.S. Small Business Administration.
“Cash is king,” as the old saying goes. In business, cash serves several purposes. It is used to meet cash obligations. It is maintained for unexpected issues and invested for future needs of the business.
When cash is received and when it is released are critical for the success of a business, leading to the operating cycle.
The operating cycle is the flow of cash through a business, which can be explained using three categories of business activity.
The first activity is business capital. Business capital is cash entering the business through loans from creditors and investment from owners.
The second activity is the production of goods, services or both. During the second activity, employees are paid and buildings, equipment, materials and supplies are purchased.
The last stage of the operating cycle occurs when cash is received by selling goods and services. The monies are used to pay taxes and debts, returned to owners and used to continue the business activity.
Unfortunately, there are many areas where a breakdown in cash can occur in the operating cycle. One of those areas involves current assets.
Current assets are items the business owns that will convert to cash in one year or less. Current assets are usually cash, marketable securities, inventory and accounts receivables.
The most difficult of the four current assets to convert to cash is accounts receivables. To avoid problems, closely monitor accounts receivables and have a firm collection and credit policy before extending credit.
Another deterrent to the smooth flow of the operating cycle is the time between buying producing inventory and selling the inventory. The “just in time” concept can be a valuable tool to help in the timing for converting inventory to cash. Selling old and obsolete inventory is another important way to free up cash for other uses.
Growing a business too fast can also impede positive cash flow.
According to David H. Bangs Jr., author of “Business Planning Guide,” a business should not expand until employees’ overtime is piling up, there is no more room in the facility to grow, and there is a waiting list of customers ready to buy a company’s product or services. It is wise to develop a financial plan that incorporates several what-if analyses before deciding to expand a business.
Having a cash reserve is critical to a positive cash flow. It is smart to have money set aside that can cover necessary obligations. Cash flow includes managing all cash inflows and outflows. A business owner cannot be concerned with making a net profit only by the management of income and expenses. A successful business owner will manage the operating cycle effectively, which in turn means having a profitable business.
Sandra Taylor-Sawyer is director of the Small Business Development Center at Clovis Community College. Visit the center at www.nmsbdc.org/clovis or call 769-4136.