One of the fundamental truths of business is that cash is king…
Recently, we were surprised as we talked to the owner of an established, well-known firm. He was honest about the effect the economy was having on his sales and commented that he’d reduced staff and expenses for the time being, and as a result, was having to wear quite a few hats—more than he had in many years. We were impressed and understood one important reason why his business had lasted for so many years and will continue to do so.
It was because he stayed within his means.
An industry slump will create challenges for most any business. Some are in a spend-and-grow mode when the slump begins. Hoping for a quick turnaround, they keep spending. When they realize that the turnaround might not come soon, they find that they are too low on cash and often can’t recover in time. One of the fundamental truths of business is that cash is king. When you have cash, you have choices and options. When you run out of cash, the game is over.
On the other hand, too many firms run so lean that they are at risk of shutdown if any large problems arise. Owners must find out where cash goes, where it should go and how to stay in a comfortable range.
When businesses spend cash on equipment or inventory, they are reducing their options. It may be both necessary and wise to do so but converting cash to less liquid forms like excess inventory puts a company at risk of not being able to pay its bills.
Here are some guidelines that will help you keep cash as king in your business…
TRACK GROSS AND NET PROFITS MONTHLY, WATCHING FOR DEVELOPING TRENDS
At the end of each month, quickly determine if you’ve made a profit. Generally, consistent profits lead to good cash flow. If you’ve lost money in a month, act quickly to stop the bleeding. Hoping for a better month next month isn’t enough. Reduce costs, or make the sales go up immediately—but don’t tolerate a loss for long. Develop a Key Performance Indicator (KPI) to track this. (Download our guide to creating Key Performance Indicators to help get the business results you want.)
TRACK YOUR CURRENT RATIO AND AVAILABLE BORROWING CAPACITY
Borrowing money is one way to get cash and can be an effective strategy to leverage your assets and make a better return on your investment. But if you’re not both careful and profitable, debt will create an even larger hole to climb out of and a debt service burden that may dog you every month thereafter.
The Current Ratio compares a company’s current assets to its current liabilities. It is a measure of your company's ability to pay short-term obligations (generally those due in less than 12 months). Have your accountant calculate this monthly including the current portion of long-term debt. Set a monthly standard and create a KPI for your Current Ratio. Our clients use our One Page Scorecards to track this each month to be sure they stay within industry norms.
LIVE WITHIN YOUR MEANS
This is really about business discipline…making your business live within its means. And in tough times, it often means working harder than you’d like, for less money than you deserve. Of course, a business must spend some money. But of the cash you can afford to spend, focus it on the one or two things that really drive your business. This is money well spent and will keep the heart of your business pumping well. When the economic environment improves, you’ll be there, ready for action and growth.
IDENTIFY AND TRACK CRITICAL ACTIVITIES THAT DRIVE RESULTS
Of course, figuring out what one or two things really drive your business is much harder than it sounds. Most business owners don’t know the answer, and instead spread their efforts and cash to all areas of their business—doing an average job at all of them, but never a stellar job in the one or two areas that really count. In downturns, below-average performers have a high failure rate; average performers sometimes make it but are generally weak when the economic recovery arrives. Only the businesses that do an above average job in the key areas can stay strong—and can often grow—in an economic downturn.
Use KPIs to track those results of key strategies tied to objectives that you believe are important to your business. Over time, those that actually drive your business will become apparent.
ACTION STEPS TO TAKE SO YOU CAN REACT QUICKLY WHEN THE NEED ARISES
- Track and measure key items monthly.
- Keep enough cash on hand to run the business through a downturn or problem.
- Cut back on expenses before you run too low on cash.
- Focus your cash expenditures on the one or two areas that drive your business.
If you are one of the businesses that has seen its cash and profit position continue to slip, we encourage you to make some painful decisions now, so that next month, and each month thereafter, your company’s financial health begins to return. And if you’ve already been making the cuts and sacrifices each month, know that you are likely now ahead of much of your competition, and that the industry rebound is closer now than it was last year.