Written for EO by Terry Lammers, certified valuation analyst and managing member of Innovative Business Advisors.
After 24 years of raising children, my wife and I will become empty nesters soon. When I see a young couple with children, I think, “How the heck did we raise three kids into responsible adults?” That feeling reminds me of what starting a business can be like: It’s expensive.
Starting a business comes with a hefty price tag. You have to buy equipment, lease an office and hire staff. When fighting for survival, you aren’t reviewing financial statements. You know only what’s in your checkbook.
Your vision for the company started long-term, but in the trenches, all you can consider is how to make it through the day, the week, the month.
When I returned to the family fuel business, the twentieth of every month was stressful because motor fuel taxes were due from sales the month before. I’d head to the post office hoping there was a pile of checks. I wasn’t thinking big-picture; I was trying to manage my checkbook. Going the extra mile to make the next milestone was almost like a badge of honor.
Shifting Your Focus to Cash Flow
Hopefully, you can get your head above water and have some predictability month after month, like when your kids grow up and don’t require constant supervision. You can take the time to prioritize your finances and see how healthy the business is.
Now is the time to switch your focus from the checkbook to key performance indicators—accounts receivable days, accounts payable days and inventory days—that will help you manage cash flow.
The turning point for me was when my company got a line of credit on a borrowing base certificate. Getting a line of credit to support receivables was going to release monetary stress. But our value and ability to succeed were going to be judged by others.
It’s at this point that you need to understand how to generate positive cash flow to the bottom line. Comparing the cash flow to the company’s net income helps analysts and investors see how well a business is run and how much money the company brings in.
My company had to fund 15 days of sales before it received money from what was sold, which only became harder as sales increased. If my sales were US$100,000 a day, times 15 days, that was US$1.5 million in capital I needed to fund that gap. When sales shot up to US$200,000, that gap ballooned to US$3 million. If the bank had blinked on my line of credit, I was done.
We usually earned a profit at year’s end, but we were starving for cash to run the company. It’s like stretching a rubber band: If you go too far, it snaps.
Useful Tips for Understanding Cash Flow
When your kids mature, you send them to school to learn and from teachers. As your business matures, you need the right people in your corner to help you grow it—a CPA and a business coach. Your team can challenge ideas, refocus and mentor you to stay at the top of your game.
Creating a set of KPIs to assess the financial performance of your company makes it easier to create long-term goals and monitor what your bank thinks of your business’s progress. That’s why accounts receivable days, accounts payable days, and inventory days should be kept on the top of your mind.
You might be in the weeds and thinking about your next loan payment instead of the long term—and that’s OK. But soon, it might be time to look to accrual accounting so you can shift your thinking to a cash flow mindset to better grow your business.
Terry Lammers, certified valuation analyst, is managing member of Innovative Business Advisors. He and partner Steve Denny launched the business in 2014 to perform business valuations, help people buy and sell companies, and provide exit planning and consulting. Terry is the author of “You Don’t Know What You Don’t Know: Everything You Need to Know to Buy or Sell a Business,” and he was president and owner of Tri-County Petroleum for more than 20 years.