Even Healthy Businesses Occasionally Experience This Issue

Avoid a “Liquidity Ambush” in your small business with the right tools for success.

Have you ever felt things seemed to be going very well, then suddenly realized something wasn’t quite right?

When it comes to having enough cash, small businesses can never feel too comfortable. Sometimes, a short delay in settlement on one hefty invoice can upset the best plans.

Your ability to estimate cash flow is one of the predictors of success for a small or mid-sized business. Owners know that looking at the P&L is not enough.

Many numbers feed into your cash status, including accounts receivable, inventory, accounts payable, capital expenditures, and debt service. You already know good cash-flow management requires a laser focus on each of these drivers and attention to credit terms and price discounts.

What else is needed?

Avoiding A Liquidity Ambush

Negative cash flow hits everyone at some point, but it doesn’t have to be a corporate killer. The secret to a healthy business is how you manage liquidity.

Liquidity enables you to raise cash when needed, either through timely conversion of assets such as inventory or borrowing new funds despite the existing debt. Liquidity is improved every time you settle a receivable by collecting the cash.

To avoid ambushing your small business, be on the lookout for signs of a coming liquidity issue.

It is easy to assume the best. For example, you can double your sales and still go broke if liquidity stays flat when growing your business. During these periods, expect to make investments and incur expenses exceeding revenue due to R&D, capital needs, paying employees before billing the work, and other factors.

Regardless of the causes of negative cash, you want to ride out possible dry periods that may occur. Having advance warning about a cash shortage allows you to take action to address the shortfall. Owners can anticipate trouble by watching leading indicators that will flag trouble signals.

These Indicators Need Watching

Since liquidity provides the cash when needed, the best strategy is to manage the business holistically. Having good financial health metrics and watching for signs of deterioration will give the early warning required to keep growing.

While cash flow estimates might be calculated either weekly or quarterly, liquidity is monitored after the end of each month using simple measures and ratios:

• Working capital
• Acid-test ratio
• Current ratio
• Payables turnover
• Average collection period
• Inventory turnover

Debt capacity metrics, while lesser-known, are watched by lenders but do not guarantee funding. Many banks canceled credit lines during the financial crisis and called in loans, even from credit-worthy customers. Debt capacity is measured three ways:

• Debt service coverage ratio
• Debt-to-total assets ratio
• Debt-to-equity ratio

Using The Right Tools Provides The Information You Need To Act Quickly

With sophisticated but affordable software, you can see the effect on cash flow from changes in sales, purchases, employment, borrowing, or capital asset planning. These tools also show how changes in financial statement assumptions flow through your Statement of Cash Flows.

Rather than putting more debt on the balance sheet, many businesses are turning to innovative tools, including payroll funding which provides stand-by borrowing at no cost until requested and used.

The right tools make it easier to foresee the future and take early action. Firms that exercise good cash and liquidity management practices continue to make investments needed to compete while keeping working capital loans off the balance sheet and bank fees off the income statement.

---