In any business, cash flow is the name of the game. Nothing will put a business under more surely than failure to well-manage its cash. This is something that every small business struggles with.

A bank balance of $10,000 may feel quite comfortable to the entrepreneur --- until he suddenly realizes that he has $15,000 of bills to pay from it. To avoid such surprises, entrepreneurs quickly learn to do cash flow projections -- tabulations of expected revenues and expenses for the next few weeks or months. Such projections are effective -- to the extent they are kept current and accurate.

However, there is another tool to monitor and control cash flow, especially useful to manufacturing companies, that such companies may wish to consider -- the Cash Flow Graph.

This is a running plot of cumulative "orders", "sales", "cash in" and "cash out". It's beauty for cash flow planning is the fact that what happens to your "orders" will be reflected in your "cash in" a time-to-ship plus time-to-collect later. If those times are running, say 6 weeks each, this gives you a running 12 weeks advance knowledge of your "cash in" -- plenty of time to do what you need to do to avoid cash problems.

Construction

The Cash Flow Graph is constructed as follows:

• Starting "cash out" = 0
• Starting "cash in" = Starting "cash out" plus Current cash balance
• Starting "sales" = Starting "cash in" plus Current accounts receivable
• Starting "orders" = Starting "sales" plus Current backlog

and updated weekly as,

• Cum "sales" at week(n) = Cum "sales" at week(n-1) plus Sales week(n)
• Cum "orders" at week(n) = Cum "sales" at week(n) plus Current backlog
• Cum "cash in" at week(n) = Cum "sales" at week(n) minus Current accounts receivable
• Cum "cash out" at week(n) = Cum "cash in" at week(n) minus Current cash balance

where

• Sales week(n) is what you've shipped and invoiced during week(n).
• Current backlog is what you have open orders to ship. (I included in backlog only that for which I had signed, hard-copy purchase orders in hand (i.e., POs I was willing to build against). But other definitions are equally appicable -- so long as they're consistently applied.)
• Current accounts receivable is your total of all open (i.e., unpaid) customer invoices.
• Current cash balance is your total liquid cash (i.e., cash in bank and/or money market).

I maintained these graphs on 11"x17" graph paper (17" vertical) over my desk for many years -- and they proved invaluable.

Planning

The example graph in the inset shows an (impossibly) stable business. The "order", "sales", "cash in" and "cash out" rates are constant week after week. However, it doesn't appear to be a very healthy business since its "cash out" and "cash in" rates are equal. What we should be seeing is the "cash in" and "cash out" lines diverging as cash builds up (at a net-profit-before-tax rate). (Of course, this appearance of unprofitability may simply be because the owner is taking out all the "excess" cash.)

Time-to-ship is a measure of the resources (labor, materials, outside services, etc.) that you're putting into building and shipping product -- and your efficiency in doing so. Time-to-collect is likewise a measure of your collection efforts.

Now let's assume that the "orders" line starts accelerating (i.e., curving) upward. Time-to-ship will start to lengthen, i.e., the "sales" line will tend to continue along its present slope -- unless you apply more resources to accelerate shipping. Of course, if you do, these added resources will have to be paid for your payables-time (4 weeks?) later.

If you believe your accelerating orders will continue (i.e., that they're not just a temporary blip), test whether or not you can "afford" them. To do so, (lightly) project out your "cash out" line with those payments added. Then (lightly) project out your "sales" line (recognizing that there may be some delay between the adding of resources and the consequent acceleration of sales). Then (lightly) project out your "cash in" line, a time-to-collect later than your projected "sales" line.

Now look at your projected cash balance. If it looks good to you, go ahead and add the needed resources -- it looks like you can pay for them out of cash flow.

If your projected cash balance doesn't look that good then you either need to raise some cash (debt or equity) to fund the growth - or accept the consequences of lengthening your time-to-ship.

There is no "right" or "wrong" to this decision. If you can raise the cash at an acceptable cost, do so. (Note: If you have receivables financing, don't overlook the fact that your projected receivables balance has increased).

If you can't raise the cash at an acceptable cost, then your lengthening time-to-ship will automatically reduce the slope of your "orders" line (through order cancellation) to what you can afford to ship. But if this is the case, better you not let that reduction happen automatically.

Instead, take the initiative. Recognize that some customers are more profitable than others. And rather than waiting for customers to cancel randomly, cancel the least-profitable yourself -- so that you can more adequately service your more-profitable. That's called "skimming the cream" -- and is not at all an unreasonable response to cash and investment problems.

In any event, the Cash Flow Graph lets you make these kinds of decisions -- with the best available data in front of you -- long before they become cash crises. Of course, you still have to make timely decisions. If you defer the decisions, cash crises will result -- but at least you will have had plenty of advance warning.