How to Determine if I Will Run Out of Cash

Will You Run Out of Cash?

This is a great question, one that most business owners lose a lot of sleep over. Most folks have spent the recession focused on reducing expenses to a bare bones point but you still always wonder if you'll have enough cash flow to operate.

The secret to not running out of cash is working capital – simply defined as Current Assets minus Current Liabilities. However, simply looking at your working capital or your current ratio (current assets / current liabilities) can be flawed as you could have a great current ratio and still be in a cash flow crisis because you have too much inventory or too many customers that have owed you for much too long.

An approach that will make you sleep better at night is to set a realistic target and measure it in a realistic manner. I would suggest starting out with setting a month's operating expenses as a starting goal. Now, to calculate using a more conservative but realistic formula:

Non-Manufacturing:

• Current Assets : Cash + Accounts Receivable < 60 Days.
• Current Liabilities: Accounts Payable + Credit Cards + Lines of Credit + Twelve Months of Principle on Long Term Debt + Other Short Term Liabilities (e.g. payroll taxes, 401(k) contributions).

Manufacturing:

• Same formula as above but add the lesser of thirty days inventory (e.g. what do you spend each day on materials based on your cost of goods sold?) or your actual inventory.

The results might be surprising and disheartening. That's okay – but it is realistic. Now, what do you do about it?

1. Considering converting some short-term debt to long-term debt – in other words if you have a vendor that you owe a lot to BUT you purchase a lot of materials from they may convert existing payables into a two year or three year note.
2. Look at collections policies – if you have a lot of old receivables it may be time to fish or cut bait. Fish by offering a significant discount for payment – and consider this in future sales to this particular customer. Cut bait (meaning, cut the customer) if you don't think there's going to be a continued relationship – turn the matter over to an attorney or a collection specialist.
3. Stay on top of invoicing – is there anything out there that could be invoiced but hasn't?

Once you've got a month, start working upwards to a month and a half, then two months. Once you've hit around three or four months you've probably reached the point where there is a better use for the excess working capital (e.g. investing back in the company, investing in other things).