Cash Flow Problems Don’t “Just Happen”

It is a myth to think that cash flow problems “just happen.”

You would be shocked and amazed at the number of businesses that fail because the owner did not see a cash flow problem in time to do something about it. One thing I want to really help you to see is that cash flow problems can almost always be seen far enough in advance to do something about it.

Rarely is a cash flow problem a sudden event. It is almost always something that accumulates over time, and it is not difficult to see it coming.

Here is a real-life example I experienced while working with a small business.

The president of the company had some concerns about his accounts receivable. He thought the process for collecting receivables from his customers was not functioning as well as it could. Money was tight, and he believed the primary reason was a slow-down in collecting receivables from his customers.

The first thing I did was to ask the two critical questions from my book Never Run Out of Cash:

1. What is the cash balance right now?
2. What do you expect the cash balance to be six months from now?

He didn’t know the answers. His response was that cash was “a little tight right now.” This turned out to be a dramatic understatement.

My next step was to spend some time in the accounting department, which, as the keepers of the accounting records, is where one should be able to find the answers to the questions. And find the answers I did!

Here is what I found:

• Cash wasn’t just “a little tight right now.” The dollar amount of vendor invoices in the system to be paid (accounts payable) was three times more than the cash available to pay the invoices. More than half of the invoices were already past due.
• Not all the invoices had been entered in the accounting system. There were fairly recent invoices that were sitting in a stack to be entered later. The accounting department personnel were in no rush to enter the invoices because they knew they would not be able to pay them anytime soon.

The reports that had been printed to show the cash balance and the accounts payable balance (bills to be paid from the cash balance) did not even show these bills. These invoices went into a stack I call the “these will be entered closer to when they can actually be paid” stack. I have seen this happen in many companies that have cash flow problems. Accounting is forced to delay payment on some invoices and not pay others at all. Vendors then start calling to demand their money.

The vendor’s favorite question is, “When will I get paid?” After several calls, they start to sense that the company is in trouble. Then they get upset and rude with the person on the phone. That’s when it gets ugly—and a bit personal. It’s hard for the clerk in accounting to take the heat from a vendor who feels like he is being cheated by the company. The vendor provided a product or service to the company and he wants his money when it was promised. The vicious cycle continues.

Accounting is now spending much more of its time fending off vendor calls. Another chunk of time is spent fending off people inside the company who are also irritated because vendors are starting to call them and threatening to cut off products or services.

• A small amount of cash was on hand but had been put off limits for paying the bills. Accounting had been instructed not to use that cash because it was to be used for an investment that was planned in about 30 days.
• A schedule had been prepared that attempted to project cash flows for the next 12 months. However, the approach to the schedule was confusing (for the business people and the accountants) and difficult to understand.

The Decisions Came Easy Once the Facts Were Clear

I reported back to the president what I had found. My approach when I do this for a business is to bring them the answers to the two key cash flow questions. My job is to make sure they can answer the two questions instantly from the information I provide.

In this case, I sat down with the president and gave him the facts and a list of what needed to be done. We reviewed the findings and precisely what was going on with his cash balance.

Here is a summary of the realizations he came to after seeing the cash flow information in a new way:

1. His books were not accurate. All the invoices from vendors were not yet in the accounting system. Any numbers he looked at from the system right now were inaccurate. He realized this was a big problem that had to be fixed immediately. He had bad financial information.
2. He had to abandon the planned investment. He now could see clearly that if he made this investment, the company would run out of cash within three to six months of writing the check.
3. The cash set aside for the investment should be used to pay all existing vendor invoices. He realized that he could not run a company that does not pay its bills. It was an incredible waste of time for him (and all the other people in the company who were constantly fighting the cash flow fire) and it was a terrible business practice. The president was being forced to divert his focus from doing what he did best—taking care of customers and selling more product.
4. His accounts receivable collections had slowed somewhat, but not as much as he thought they had. He realized this was only a small part of the cash flow problem.

The president was genuinely surprised at the size of his cash flow problem. He knew the cash balance was uncomfortably low, and he knew “some bills” were not being paid on time. What he didn’t know was that the past due bills dwarfed his cash balance. He also did not realize there was a stack of invoices that had not even been entered in the accounting system yet. The reports he was being provided from time to time about the cash and unpaid bill problems were not accurate. They were incomplete.

As a result, if he had continued along the path he was on, he would have written the check to make the investment that had previously been planned. He would have done it on the assumption that the company could continue managing with cash being “a little tight right now.”

The Two Critical Cash Flow Questions Saved the Company

Once the president knew the answers to the two critical cash flow questions, he knew he had to change course—and do it fast.

Presented with the answer to what he expected the cash balance to be six months from now, he knew exactly what he had to do. The president knew that the investment could not be made.

It became perfectly clear that making the investment would bankrupt the company within just a few months of making it, all because he did not have an accurate view of what the company’s cash balance was expected to be in six months.

This was an important realization for him and his business. Before he had the answers to the two questions, he felt confident in making the decision to go forward with the investment. After he had the answers to the two questions, he was confident in making the decision not to go forward with the investment.

The exact opposite decision was made once he had an accurate view of his cash balance and where it was expected to be over the next six months. This made all the difference for his company.

Have you ever tried to make an important decision like this without knowing the facts?

Don’t make this mistake in your business.

(This blog post is from Chapter 8 of my book Never Run Out of Cash: The 10 Cash Flow Rules You Can’t Afford to Ignore. The book provides an easy-to-understand, here’s exactly how you do it guide to help you better understand and manage the cash flow of your business.)

Philip Campbell is a CPA, financial consultant, and author of the book A Quick Start Guide to Financial Forecasting: Discover the Secret to Driving Growth, Profitability, and Cash Flow and the book Never Run Out of Cash: The 10 Cash Flow Rules You Can’t Afford to Ignore. He is also the author of a number of online courses including Understanding Your Cash Flow – In Less Than 10 Minutes. His books, articles, blog and online courses provide an easy-to-understand, step-by-step guide for entrepreneurs and business owners who want to create financial health, wealth, and freedom in business.

Philip’s 30 year career includes the acquisition or sale of 33 companies (and counting) and an IPO on the New York Stock Exchange.

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