Keep your business thriving by following the 5 rules of cash flow.

By Tim Keane

For most businesses, cash comes from a variety of sources—the best source being sales revenue. Managing cash is a critical function for all of us with new or growing ventures. This is especially true when we have revenue, but our cash flow is at or below break-even.

Here are five tips garnered from long experience in the cash-flow trenches:

1. Use your business model to build an early warning system. A business model reveals how your business plans to make money. It incorporates all of the assumptions you are making about your business. You can easily check frequently to make sure the timing and amount of your assumptions are accurate.

Those assumptions include:

• How much you will spend to make your product or provide your service, and whether you make a big investment in the systems needed to do it yourself, or pay a vendor to do it for you;
• How much profit margin you will make on each sale;
• What price you will charge relative to others in the market;
• What your operating expenses are; and
• What your operating income is;
• The timing of all of these activities—how long it takes to make your product or provide your service; how long it takes to get orders; the customer repeat rate; and so forth; and
• A break-even calculation that tells you how many units you must sell to have neutral (that is, breakeven) cash flow.

From this data you can chart the amount and timing of cash requirements. This is the central financial management skill for both startups and growing ventures.

2. Burning the boats is almost never a good idea. Every entrepreneur is faced with a choice: making do with less, or swinging for the fences. “Burning the boats,” by spending more cash than is prudent and leaving you little or no margin for failure, is very risky. If the business model is proven and the input of cash at this level will create real growth, fine. But it’s a rarer situation than most of us think.

3. When seeking cash, match the source of cash to the risk associated with the investment. Banks don’t invest; they lend money at low rates, and they expect to be repaid. Investors seek opportunities to take more (apparent) risk than a bank—and earn a higher rate of return. If you have a bankable business, then debt is your best source of cash. An honest investor will be leery of a situation in which the return opportunities seem much higher than they need to be based on the risk.

4. Clearly understand your biggest source of cash—the customer. You need to know, directly, what the customer is thinking, how well satisfied they are with your product or service, what else they are considering, and if their repeat purchase rate is going up or down. Get this information yourself, not from someone else in your company. There’s no cash management substitute for firsthand information about the biggest source of cash most of us have.

5. Make everything possible an indirect cost. There will be plenty of time to build a factory or hire more people—after your business model is proven. In the meantime, wait until objective proof exists of your business model’s performance. Then, and only then, investigate ways to use capital investment to lower per-unit costs.

Keeping these five principles in mind will help keep your cash flow steady and your business growing.