Drive Internal Cash Flow and Improve Profitability

This is the first part of a series that looks at the four core business systems you need to have in place to operate at an optimal level and maximize your internal cash flow from operations. The first to be covered is cash flow. The second part discusses measuring operations with key financial information, the third looks at making good decisions with solid business information and the fourth examines managing your revenue to plan for growth.

Have you ever gone white water rafting, kayaking or canoeing? If you’ve been to the same river more than once, you know the water never looks the same twice.

The first time I rafted, the water was really high. We moved along the river with very few problems. The next time I went back to that river, the water was down and we had to work our way around many rocks.

Businesses face these same rocks. When the revenue tide is high, you sail over many things, not knowing what lies beneath. But when it’s down, it’s harder to navigate the obstacles you can now see. It’s easier to steer your business when you have the cash flow you need.

The most important number you should know in your business is your cash flow from operations. But that number is not on your balance sheet. It’s not on your income statement. It’s buried on your cash flow statement. Having cash flow from operations and taking steps to maximize it is the key to running a healthy business.

The most important number you should know in your business is your cash flow from operations. But that number is not on your balance sheet. It’s not on your income statement. It’s buried on your cash flow statement. Having cash flow from operations and taking steps to maximize it is the key to running a healthy business.

Cash flow from operations comes from a balanced focus on health and growth. Improvements in these areas can send your cash flow soaring and keep you in control of your business.

Inventory. Even though products sold differ for every business, the concept is the same. Do you know your inventory turnover – or how many times a year you actually sell your inventory? For example, if you sell $1 million of product a year and have an inventory of $250,000, you sell your inventory four times a year. If you can sell your inventory six times a year instead, it takes less cash to fund your inventory because you have less of it at any given time.

Businesses sell inventory and make money. Museums keep inventory and don’t make money. If something has dust on it, sell it.

Some businesses claim they don’t have inventory, but that’s not true. While you may not have products to sell, your inventory is your people and equipment. It’s measured not in terms of how quickly you sell it, but how efficiently you use it – your utilization and realization.

Accounts Receivable. How many days does it take from the date you ship the product or perform a service for a customer until the date you get paid? Yes, the date you did the work and not the date you sent the invoice. Is there a way to invoice more frequently to shorten your billing cycle? Even a 15-day improvement sending invoices can make a big difference.

You may not be able to make your customers pay faster, but take steps to make sure problems don’t happen. Consider calling a week after sending the invoice to make sure it was received. Call on non-payments at 30 days and not 90. Or make friends with your customer’s accounts payable clerk so you have a champion within the company who can push for you to be paid.

Gross Margin. How much money do you make when you sell your product? There are numerous levels of cost associated with making your product or delivering your service. The difference between production costs and sales revenue is your gross margin. You may think the only way to improve gross margin is to raise your prices, but it’s not.

Is it possible to get a 2 percent increase on your gross margin? How about 5? Instead of getting it from prices, look at operational efficiency, production and purchasing. This is where you should micromanage your business. It’s how you understand every aspect of production and operations. But you’re not going to find the data needed from your accounting system. You need production and cost data that comes from analysis and planning.

Healthy Sales. Not all sales are healthy, but they should be. Unhealthy sales can include either too little or too much revenue from one customer or low customer profitability. You need to study your sales so you fully understand where they come from and what problems may arise. If you can identify negative trends early on, you can make decisions before you find yourself in a cash crisis.

Keep a close eye on all aspects of your revenue pipeline. This is often the lifeline of your company. Healthy businesses can successfully move a target to a customer. By tracking your sales efforts, you can see how opportunities lead not just to sales, but to healthy sales.

Build Your Cash Flow

There are only three places where you can get cash: from an investor, from a bank or from your business. Investors are hard to find and not for everyone. Banks are not the endless supply of cash that many people hope for. That’s why generating internal cash flow, or cash flow from operations, needs to be a professional discipline within your company.

Too many businesses generate income and have no cash. Then they get into trouble and run to the bank. Rather, go to your bank with a business that is healthy – one that generates cash flow – and use bank financing to grow your business. It’s a wonderful process.

Don’t wait until a rock is right in front of you. Plan for it and you’ll be able to successfully navigate your way around it – right into increased profits and steady cash flow.

This article was originally published in The Rea Report, a Rea & Associates print publication, Spring 2012.

Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.