How to take the mystery -- and uncertainty -- out of your company's cash flow

Cash flow, quite simply, can make or break a business. But it's the kind of issue that often gets lost amid the day-to-day pressures of growing a company. Most owner-managers have enough to worry about just increasing sales or keeping their bottom lines healthy. And cash-flow analysis is easy to overlook, sounding as it does either ridiculously simple -- like balancing a checkbook -- or painstakingly obscure, as accountants throw around terms like amortization and depletion.

In truth, cash-flow analysis is a straightforward task that is enormously rewarding for any manager eager to understand his or her company's current standing and future prospects. And the risks of avoiding this issue are too great to ignore. Entrepreneurial companies, which usually have limited supplies of working capital and even more limited lines of credit, are most vulnerable to cash-flow catastrophes. Worst of all is the prospect of being unable to pay monthly bills despite paper profits. As companies grow, cash-flow complications can stymie their efforts to expand.

For John Brandon, the founder and owner of Via Systems Inc., in Colorado Springs, Colo., cash flow wasn't a concern -- it was a nightmare. Ten years before Brandon had watched an earlier computer venture fold because he and his partner "lacked skills in managing and marketing." This time Brandon's software company had such big-name clients as the United Nations and Fujitsu, annual sales approaching $1 million, and strong prospects for growth. But he was also having trouble sleeping: "I had developed enormous anxieties that we were going to run out of cash and not be able to pay for the expansion I wanted to take on."

Like many entrepreneurs, Brandon thought that cash-flow analysis belonged in the textbooks. "I'm an engineer by training, a technical guy who had bootstrapped my company to a level of success without any debt. To me, cash flow meant that if I looked at my checkbook and had enough money, I was OK." But in early 1988, when Via Systems was six years old, Brandon found himself in a typical bind: he had a one-product company and had to decide whether to diversify or "wait for the product to run out its life." He adds, "I knew it was time for me to change direction. But because I'm conservative about my finances, I couldn't think about diversifying without knowing for certain that I had the cash to support the move."

Brandon's instincts were right on target. Cash-flow analysis, although always useful, becomes particularly important whenever companies -- whatever their size -- reach milestones: bringing the first product to market, diversifying product lines, significantly adding to staff, acquiring or divesting divisions, and so on. In other words, whenever your company's monthly bills are due to rise significantly, it's time to analyze cash flow.

Cash-flow analysis is the kind of task any chief executive can work through, so long as he or she has clear financial records, a well-defined approach, and a savvy financial officer or business manager. But Brandon and his wife, Kathie, who is the company's bookkeeper, decided they wanted outside guidance. "It was useful to have someone who was willing to challenge all my basic assumptions and help me examine everything from the ground up," he says. So he consulted Grant Thornton, the accounting firm that handled his tax work. It was a fortunate move; the firm's approach to cash-flow issues is blissfully commonsensical and free of accounting jargon.

Brandon's worries were twofold. First, was there any basis to his fear of running out of cash? Second, if he added new software products through manufacturing and licensing arrangements with independent designers, would he have the cash to pay for packaging, manual preparations, advertising, telephone support, and other services? "I had a staff of six people and two products that were ready to come to market," he recalls, "and a few others that looked like good prospects. But I was wringing my hands because I didn't know if we could actually afford to grow." To Paul Parish, the Grant Thornton senior manager and management consultant who worked with Brandon, the numbers Via Systems needed were simple and standard: a concrete cash-flow analysis going out 12 to 18 months and then a broader set of projections for the three-to five-year span. But rather than starting out with a lot of complex mathematical equations, Parish -- with Brandon's help -- turned the spotlight on life at Via Systems.

It wasn't fun. "We worked straight through the week between Christmas and New Year's," says Brandon. "And it was hard work, poring over all my financial records and trying to figure out exactly what happens to every single dollar we earn. I couldn't just get away with saying, 'Hey, this is what I expect to spend on my phone bill and this is how much I'll sell to cover it.' "

Parish's initial goal -- one that is all too commonly overlooked in cash-flow analysis -- was to identify inefficiencies in the way Via Systems handled money. As he explains, "Cash flow is a cycle. Once a company makes a sale, cash passes through various stages from billing to disbursements and so on. The more efficiently it passes along, the less cash any company, big or small, needs during any particular month to keep its operations going smoothly." In Brandon's case, this stage was vital. Since he expected to increase costs as he added new products, he had to keep his cash needs as low as possible. Parish analyzed six phases of the cash-flow process:

* Cash receipts -- the way Via Systems prepared and mailed out bills, managed accounts receivables, followed up on delinquent accounts, and so on.

* Cash concentration -- the efficiency with which Via Systems' earnings, once collected, were drawn into a network of lock boxes, bank accounts, and so forth.

* Disbursements -- the way that bill payments were timed.

* Forecasting -- the accuracy and usefulness of Brandon's projections about when cash would enter and leave the business.

* Inventory -- how much cash was tied up in raw materials and unsold goods.

* Bank relations -- everything from how well money flows between different bank accounts to the company's lines of credit and existing loans.

Naturally, this analysis and the risks inherent in each of the six phases differ according to the company and industry. Via Systems, for example, did an excellent job of collecting accounts receivable and had little cash tied up in excessive inventories. But on a micro level, Parish identified plenty of ways to trim the company's cash-flow machine. "He forced me to analyze costs in terms of whether they were justified by sales," Brandon recalls. "The result was I stopped attending some conferences and decided to stop spending $15,000 to produce four-color advertising brochures when one-page black-and-white would do." Parish's analysis confirmed Brandon's apprehensions about one glaring weakness of Via Systems. The company had no lines of bank credit and thus no outside protection against months when cash flow might turn negative, a big risk for a company considering introducing costly new products.

For other companies, cash-flow glitches might turn up elsewhere. "To a leasing company that expected large quarterly receipts, for example, even a day or two delay in getting money concentrated in bank networks could be costly," emphasizes Parish. "Or a manufacturer who was keeping inventories unnecessarily high might be tying up cash that could be used to pay bills or earn interest in bank accounts." A typical problem for all companies is mistiming their bill payments. "Some companies pay too early and wind up forgoing the interest they could have earned on their cash," says Parish. "Others pay too late and either wind up with late penalties or being forced to buy on a COD basis, which really kills them."

Once Parish had worked out a bare-bones cash-flow model for Via Systems appropriate for its present size, the rest was easy. For Brandon, with more than 20 years in the computer industry, and Parish, with Grant Thornton's technical support, it was a relatively straightforward matter to project the way each new product would add monthly overhead costs and, conservatively speaking, affect sales. "We worked up a set of projections that showed us going from a positive net cash flow of over $8,000 in February of 1988 to negative cash flow totaling about $45,000 in March and April, when we started bringing new products to market," says Brandon. He smiles. "When I went negative for those two months it didn't worry me, because I had faith in our long-term assumptions." Sure enough, the company's net cash flow went back into the black by May to a healthy $5,500 and has steadily increased from there.

Think of Brandon as a cash-flow convert. "Before I did the analysis I didn't know which steps I could take. Now, I've introduced four new products to the market and we've done beautifully -- the last one exceeded our projections by a factor of three." With further plans for diversification, Brandon and Parish plan to sit down and rework the company's cash-flow projections for the next 18 months. "My cash-flow plan is a living, breathing document," laughs Brandon. "I find that these days when I feel anxious it's usually because I've fallen behind in looking at my numbers."


What to do to get reliable projections

Here are some suggestions to make your cash-flow analysis as painless -- and useful -- as possible:

* Set up appropriate records. Keep detailed financial records that make sense for your business and not just for the Internal Revenue Service. After going through the initial process of analysis with Via Systems Inc.'s accountant, Paul Parish -- and hunting down all the financial details about the company's cash flow that he simply did not know -- president John Brandon decided to switch the company's general accounts to a system that breaks down expenses, receipts, and other categories into real-life specifics.

* Look for trends. Computerize those records and assign someone, either inside or outside the company, to do a quarterly search for disturbing patterns like bank delays or slow collectibles. Once records are computerized, it's also a simple task to evaluate the accuracy of cash-flow projections on a month-by-month basis.

* Plan regular analyses. Schedule cash-flow analysis for every 12 to 18 months -- then update them every time the company contemplates a major change. If your company, like Brandon's, is growing rapidly, you'll probably find that your short-term plan is much more useful than your three- to five-year model, but do both. "Just projecting numbers sometimes helps CEOs clarify ideas or goals," emphasizes Parish.

* Go with the flow. The process really is easier after the first go-around. "We've already done the records, forcing me to justify my ideas," says Brandon. "Now, we just update the numbers as the company and my goals keep growing."