Article | November 26, 2012

How to Take Your Cash Management From Short To Long Term

By Daniel Margolis, CompTIA

Some people live paycheck to paycheck, and so do some businesses. According to market statistics produced by Corelytics, the typical IT solution provider maintains an average cash balance equal to 46 percent of average monthly sales. Meanwhile, many companies rely heavily on credit cards to make purchases and stretch cash. This is living on the edge and leaves a company in a vulnerable position, often one bad deal away from shutting down or perhaps closing its doors for good.

Ideally, a small business has the equivalent of two to three months of sales on hand. This allows business owners the flexibility to focus on growth and expansion rather than putting out fires. But even companies with a healthy reserve of cash are not immune to such panic; conditions may shift and they may have a near-death experience and need to start juggling bills in a hurry. The danger with this mode of operation is that companies pay bills as they can, but then run short when it’s time to do things like pay employees. When this happens, the company is probably not going to make it.

Another problem with operating close to the edge is that companies that do so have much less value in the market. Companies with great revenue growth but a poor cash position may be seen as badly managed – a “fixer-upper.” Companies that have a good history of cash balances with a cash trend line that matches or exceeds the rate of revenue growth are more highly valued.

The difference between taking a short- or long-term approach to a company’s finances comes down to being tactical versus strategic. Companies living check to check, invoice to invoice, are forced into tactical cash management. Companies with two to three months of cash reserves, meanwhile, have more options and can move up to strategic cash management.

Companies engaged in tactical cash management should orient themselves around these three simple steps:

  1. Build and update the list of pending payments due.
  2. Manage credit sources.
  3. Manage relationships with people and companies that you owe money.

Companies engaged in – or looking to get started with – strategic cash management should use some or all of these tools:

Three-month cash planning worksheet: This worksheet should show the categories and line items for expenses and revenues for the current month and the next two months.

Trend line comparisons: Every month you should compute the trend line (the 12-month growth rate) for revenue and for end-of-month cash balances.

Budgeting: Small companies’ budgets can be much less complicated than is required for large companies. Often it is enough to just have a total quarterly limit on expenses by category.

Spending approval process: As a company grows, it becomes important to delegate the process of purchasing and payment of some expenses. At the same time, there need to be rules that limit how much a manager can spend without approval.

Line of credit usage plan: The line of credit should only be used under specific conditions. For example, it should not be used to finance capital purchases.

Investment planning: A best practice is to create a mini-plan for each major investment. The investment plan should identify when the investment will be made, how it should impact revenues, and how and when the investment will be recovered.

Benchmark comparisons: Watching cash, debt, inventory and other measurements as a percentage of sales is essential to spotting problems within your business.

Goal setting for cash balances: Setting goals and then tracking actual performance against goals is an effective way to get the results you are looking for. Management should set goals in many areas within a company and track actual performance.

To learn more about tactical versus strategic cash management, and how to get from one to the other, go here to get CompTIA’s Quick Start Guide to Cash Management Strategies.

Daniel Margolis serves as manager, membership communications editor at CompTIA. He has worked as a professional writer and editor for over 13 years, covering a range of industries.