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ACCOUNTING

The Art of Cash Management

Tips on understanding and implementing cash management strategies. Includes how to maximize cash flow, assess your current cash position, and evaluate investment account options.
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No financial discipline is more important--and more misunderstood

Does Jeff Chasin's story sound familiar? Chasin and a partner started Commercial Credit Co. LLC, a high-tech equipment-leasing company in Irvine, Calif., just two years ago with $5,000 in personal savings. Their financial formula: land some big clients, try to collect from them quickly, and then reinvest all the proceeds into the business.

So far, the formula has clicked, pushing sales up from $11 million in 1997 to a projected $20 million this year. But with that kind of superfast growth, cash management has become a complex issue for Chasin and his partner. "At first, all we needed was a bank checking account and a package of Quicken software to keep track of sales and key financial results," Chasin explains. "But after about a year, we realized that there were all kinds of questions we were too busy running the business to ever answer. Like, what should we do with whatever excess cash we might have, and how would we really ever know for certain if we did have any excess cash?"

If you haven't considered such questions, you may be undermining your company's long-term prospects--and even its short-term stability. Indeed, there may be no financial discipline that is more important, more misunderstood, and more often overlooked than cash management. "Business owners should be thinking about this issue from day one," emphasizes Stephen King, president of Virtual Growth, a New York City-based financial-consulting firm that handles outsourced comprehensive accounting services for companies. But most don't--because they've got other issues on their minds. So long as more money seems to be coming into the business than going out, many company owners don't give cash management a second thought. And that leaves them vulnerable to all kinds of cash-flow dangers.

Luckily, the first step to improved cash management isn't exactly brain surgery: just start maximizing cash flow. "There are often ways for companies to improve their cash position simply by making certain that their billing, collections, and payables systems are operating as efficiently as possible," King observes. Aim to bring cash into the company as quickly as possible: bill promptly, aggressively follow up on overdue invoices, and, if possible, require up-front deposits when making sales. (See "Cash Management Tools," below, for additional ideas.) Then hold onto your cash as long as possible by managing your payables. That means, quite simply, take as long as you're allowed--without incurring late fees or interest charges--to pay your company's bills.

To practice a more elaborate form of cash management, you must be able to accurately assess your current cash position and make fairly reliable predictions at key intervals about how much you'll need to meet the company's expenses. Jeff Chasin and his partner were not confident about their expertise in that area. That's one reason they hired Donna McGovern, an accountant and the owner of Ideal Business Solutions, in Westminster, Calif., to serve as a part-time chief financial officer.

"They were worried about something that's a real risk for fast-growing companies," she recalls. "What if they were in a position where they had built up some excess cash and they then decided to invest it as a way of squeezing some extra profits from the business? And then, something went wrong, like they had miscalculated their cash needs or owed a client money but had their funds tied up in the wrong kind of investments?"

With McGovern's help, Commercial Credit started preparing more finely detailed (and more useful) monthly financial statements that included cash-flow forecasts. "When a company is in a fast-growth mode, it's not usually in a position to make large, long-term investments, because it will need to self-finance some growth opportunities," she notes. "Still, once you understand your cash position, you can often follow a course similar to the one families follow when building up an emergency nest egg: put small amounts of extra cash in a money-market account, on either a monthly or quarterly basis. Granted, you won't earn a fortune, but you will earn some interest while keeping the company's funds accessible."

If your company's cash flow becomes so predictable that you can set aside sums for several months or more, you might be able to make a slightly greater commitment by purchasing certificates of deposit. Although there are penalties for cashing in CDs early, those penalties should be manageable in an emergency. To minimize the risk, buy smaller CDs and try to stagger their maturity dates.

But exercise judgment. The biggest cash-management mistake a business owner can make is to take huge risks when investing spare cash. That's because it's all too easy to lose your company's cash cushion, and possibly even to jeopardize your business's survival, by making inappropriate investments (such as a risky gamble on stock-market futures or on some tiny stock you learned about on the Internet). Unfortunately, there are plenty of brokers and investment advisers willing to peddle such investments to business owners.

Sometimes investments aren't the best option at all. "When you're practicing cash management, you need to ask yourself on a fairly regular basis, How can I best make that cash work for the company?" explains Earl Zimmerman, a senior manager in the Boston office of the accounting firm Grant Thornton LLP. Be analytical. For example, Zimmerman notes, if your company has $5,000, you could invest it in a money-market fund paying 5%--but it might make more sense to use that $5,000 to pay down your credit line and save on interest payments. Moreover, Zimmerman adds, an entrepreneur carrying credit-card bills at 19.8% would be wise "to use the $5,000 to pay those bills." The key point: allocate your cash in whatever way will wind up improving your company's stability.

Then, as your company's financial position stabilizes and cash flow becomes more predictable, it's not a bad idea to begin investigating your investment options. In particular, if your company anticipates raising a large sum from angel investors or venture capitalists--and you won't need to spend it all quickly--it's a good idea to do some research beforehand so that you won't waste time when the cash arrives.

But if your company's cash cushion is smaller, don't assume it will be easy to set up an income-producing account at the nearest bank. Some bankers will tell you that your company's cash position is too small to be worth their involvement. Or they'll offer you such a piddling rate that they won't be worth your attention. "When we called the local bank where we've got our company's checking account, they offered us 2%," Chasin recalls. "Why bother?"

Fortunately, Chasin was able to identify an option he liked better: a money-market fund with discount broker Charles Schwab, paying 5% in interest. "We put about $30,000 in it and were very satisfied." Of course, the money didn't stay there. "Some growth opportunities developed that represented a more profitable way for Commercial Credit to spend its money," its founder confesses, promising to "put more money in the next time that's right for us."

That's what entrepreneurial cash management is all about.

Jill Andresky Fraser is the finance editor of Inc.

Cash-management tools

When the economy is strong, companies can lapse into sloppy cash-management practices. Don't let that happen to you. Try exploring these options:

Sweep accounts. These bank accounts are the easiest way to generate some income from your company's spare funds; however, they make sense only if the money you'll earn will be greater than the fees your bank will charge. Business owners have two types of sweep accounts to choose between:

  • Controlled-investment accounts. Think of these as checking accounts with the ultimate in zero balances. Every day, your bank will leave only enough in your checking account to cover those checks that were presented the night before for payment that day. The rest gets swept, quite early, into overnight investments. "These are the most profitable form of sweep account, but they won't work for your company if you have any electronic payments or wire transfers, since those may be submitted for payment later in the day and your account won't have enough cash in it to cover them," warns Stephen King.
  • End-of-day sweep accounts. A safer bet for most small-business owners, these accounts wait until a late-hour cutoff to determine how much to sweep into your overnight investments. Typically their investment yields are 10 to 20 basis points (.1% to .2% of the investment) lower than those offered with controlled investments.

Lock-box accounts. A lock box is a cash-management system that helps you collect your funds quickly. Generally set up with the assistance of a big money center or regional bank, lock boxes provide your company with a special zip code and, usually, quicker deliveries from regional post offices. They are especially important if you have clusters of customers in out-of-state locations and don't want to lose days waiting for their checks to arrive by long-distance mail.

Last updated: Oct 1, 2000




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