September 1, 2011

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The Cash Coaster

Smoothing Out Cash Flow Ups and Downs

Jesse Mecham

September 1, 2011

I recently tricked my six-year old into going on Space Mountain. Porter had never been on a roller coaster before. His questions were nonstop and sincere.

“Has anyone ever fallen out? Are there seat belts? What if they break?”

We climbed in, strapped ourselves down, and took off. Once the ride was over, we looked at a photo snapped of our car during a particularly precarious portion of the ride. You could barely see my son’s head above the car. His eyes spoke volumes—he was terrified.

I asked him what he thought of the experience, and his response surprised me. “That was my favorite ride, Dad.”

The picture of him during the ride and his personal response right after were in direct contradiction to one another. As so often happens, my mind wandered to budgeting.

Our financial roller coaster is full of ups and downs, dark tunnels and hard turns that make you feel like you’ll be thrown from your seat. This is especially true for businesses. You’ll have moments of reprieve, and then a huge dip where you’re blindsided by some unforeseen expense. You weather the cash flow storm, but if I were to ask how things are going, you’d tell me, “Just fine.” You tend to optimistically block out the rough spots of the past and plow forward. After all, you have a company to run.

Cost Analysis
Your objective should be to manage your expenses proactively. Look back through your P&L for the last 12 months and take note of any large, infrequent costs. They’re what create the “downs” in your roller coaster, or a cash flow crisis. For example, consider the annual property taxes on your warehouse. Every time the bill comes, you scramble, cut back or perhaps throw a little on the company card.

Instead, make every expense a foreseeable, monthly expense. Just divide by 12 and pretend your property taxes are due each month. If they equal $12,000, then you’ll set aside $1,000 each month and “pay” your property taxes throughout the entire year. This works for everything: Christmas bonuses, company retreats, new office equipment, etc.

Thinking ahead and pro-actively setting the money aside prevents huge spikes in spending. Leveling out your expenses by spreading them over the entire year makes them easier to handle.

Plan for the Dips
This method of treating future bills as “now” expenses works great when dealing with foreseeable obligations. But what about the unforeseen? Crises can be avoided by maintaining an emergency fund of three to six months’ expenses (as we’re advised to do with our personal finances).

Functioning via loans and creditors may seem like a typical (and necessary) part of the business roller coaster, but new business owners and entrepreneurs often rely on this solution too much. With the majority of businesses failing due to poor cash handling, even a month of expenses on hand would make all the difference.

Besides the obvious benefit of having cash on hand, indirect niceties result from building breathing room into your business cash flow. In business, pressure to act is usually due to a deadline. Time restraints are almost always money restraints. These strained situations lead to desperation and less-than-ideal decisions. Living so “close to the sale” invites this pattern of stress over and over again.

Think of a call option, where you have the right, but not the obligation, to buy an underlying asset at a fixed price. How much time you have at your disposal determines its worth. This can be likened to your business’ financial decisions. The longer you can keep your options open, the more valuable they become. When you’re confronted with the opportunity to hire, invest, cut, research, expand—but you’re living on the very edge of financial disaster—how much time do you have to make your choice? In essence, you have no viable options because you don’t have time. Your hand is forced—usually to reach for your credit line or rely on another loan. This inevitably runs up your business debt and furthers your (long-term) cash flow crisis.

Consider the same situation, but now you’ve built up a sufficient fund of ready cash. You have a significantly longer amount of time to decide what to do, where the money should come from and how to replenish it—all without relying on credit. You have a slew of options and, most importantly, you have time to think about your decision.

The Overall Strategy
It’s a two-pronged attack plan: First, for those predictable but often-ignored expenses, break them into manageable, monthly chunks and set aside funds throughout the year. Second, for the unforeseeable expenses, have a few months’ buffer of funds on hand at all times. This will buy you time and give you breathing room.

Managing your cash flow this way creates a much smoother, more tranquil business experience—like my son’s actual ride of choice: the Hungry Caterpillar—a coaster I was convinced to ride with him at a ripping seven miles an hour. Over. And over.

Jesse Mecham is founder of the financial software company,—because you do!

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