In a previous post I talked about cash flow management i.e. tips on generating the highest possible positive cash flow. In this post I’m going to talk about cash management. What’s the difference? Cash flow management is doing things that enhance your positive cash flow. Cash management is managing the cash that you generate in your business so that you don’t run out of cash.

Just as I have found that many managers and owners don’t understand the difference between markup and margin, I have also found that many business people with whom I come in contact don’t understand the difference between net income and cash. The best way to illustrate the difference between the two is to quote a professor I had in business school. He said, “Net income is nothing but an accounting term. You don’t pay your bills with net income, you pay them with cash.”

Over the years I have seen many companies go bankrupt even though they never reported a loss. How does a company file bankruptcy without reporting even a monthly loss? You do so by running out of cash. There are a lot of accounting tricks that can enable a business to report a monthly net profit while slowly running out of cash. The most common way of doing this is to abuse accrual accounting. I have seen a lot of companies capitalize expenses should have been expensed in the month in which they were incurred, but instead, they capitalized the expense, thereby spreading the expense over a number of months or years instead of taking the income hit in the month in which the expense was incurred. Yes, things like a new corporate brochure that will last for two or three years should be capitalized and then amortized monthly over the life of the asset, but I have seen other things such as a large refund to a customer capitalized and then expensed monthly over a year so that the expense of this refund didn’t negatively impact one month.

A lot of companies capitalize things that should be expensed when they are losing money. They do so to not report losses and/or to stay in compliance with loan covenants. Using “accounting tricks” such as this not only fails to comply with GAAP (generally accepted accounting principles)  but, in some instances can be illegal, especially when done in public companies.

One of the most famous cases of a company that went bankrupt while never reporting a loss was the 1960’s discount store chain, WT Grant. WT Grant was facing a lot of competition from a new competitor, Wal-Mart. Rather than face the music and make needed changes to compete with Wal-Mart the management of WT Grant began capitalizing expenses which should have been recognized all at once. While this allowed them to survive a bit longer than they should have, their demise was inevitable.

How do I recommend you manage cash? Well, in our company, I get a daily availability report that shows me how much credit we have available under our revolving line of credit. The report shows our availability at the beginning of the day, cash receipts received, invoices billed, checks written, and net availability both before and after accounting for checks written but not yet cleared through our bank.
If our cash gets tight we pass on taking prompt pay discounts and pay when the invoice is due, charge the payment to a credit card, negotiate extended terms with the vendor, sell unproductive assets, auction off dead stock,  and/or accelerate collection efforts with our customers. We do whatever it takes so that we don’t run out of cash.

It always amazes me when I meet with other business owners and ask them how they keep track of availability against their bank lines. The vast majority sheepishly admit that they don’t have any good idea of how much availability they have, they just wait for the bank to call to tell them that they are overdrawn. I don’t know about you, but if this were my system of cash management I would need to take sleeping pills every night.

What is your system of cash management? My readers and I would like to know.

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