Identifying Cash Flow Trouble Spots
During the bleak days of the Depression, an aggressive politician from New York named Franklin Roosevelt make a bold promise that his administration would put “two chickens in every pot and a car in every garage.” As it turned out, this was one of the few times in history when a political exaggeration was actually an economic understatement. Today, poultry is so inexpensive that it is the most common meat used in pet food. And the automobile has become such a fixture in the American home that owning just one is a handicap rather than a privilege. In fact, we have such an innate understanding of the internal combustion engine that most of us have a rough idea of how it works and why it sometimes doesn’t.
Unfortunately, many business people have not come quite as far since the Depression in their ability to discern what makes a company or organization work and what needs to be done to ensure its survival. There are basically nine “danger signals” that indicate the strength and viability of a business:
1. Declining gross income combined with operating losses. In most instances, declining sales will not be targeted as a problem until operating losses deplete cash reserves. Normally operating costs will remain high and not be adjusted as sales decline. This creates the operating losses that eat up cash reserves.
2. The absence of a month to month operating plan. Most managers do not develop an operating plan that defines monthly business goals and objectives: revenue, expenses, profit, key balance sheet targets and operational objectives. If a planning document does exist, it is often shelved and forgotten as day-to-day concerns take precedence over defined goals. When this happens, management has no means of measuring the performance of the business and is oblivious to hidden dangers.
3. Breakdown in communications between upper management and the labor force. Failure to communicate vertically creates a situation where upper management cannot identify conflicts that exist in the ongoing operation of the organization.
4. Inadequate cash flow. The ability to generate cash flow is the key ingredient in a successful business operation. While it is normal for most organizations to have seasonal fluctuations, sudden increases or decreases in revenue or expenses can have a dramatic impact on the availability of cash.
5. Inability to convert accounts receivable to cash promptly. A slow down in the collection of accounts receivable can be an indication of poor screening of accounts, granting of credit or lack of follow up.
6. Inability to convert inventory to cash promptly. A slow down in inventory turnover may signal a problem in the quality of products shipped or wrong raw material purchased.
7. Cash tied-up in nonproductive assets. Investing in buildings, equipment, and/or personnel without careful analysis of their profit contribution can sink cash into assets that are nonproductive. This normally will impede profitability and the ability of the business to fund future growth.
8. Amounts owed to vendors. When an organization is unable to meet the payment terms of their vendors, not only does it indicate that a serious cash-flow situation exists, but the future credit of the company is in jeopardy. Long-term business success depends on the goodwill a company is able to generate with its creditors.
9. Low employee morale. Most employees truly want their organization to be successful. When a company is without solid direction, morale declines and with it goes productivity.
The natural tendency of most managers is to ignore potential problems until their urgency demands attention. By systematically – preferably on a monthly basis – reviewing the corporate goals and evaluating how successfully these goals are being achieved, management will maintain the fiscal vitality of their company and eliminate the anxiety that comes from last-minute problem solving.
By Dan Lacy
Business Growth Advisor
Anderson, Indiana
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