The Entrepreneur's Guide to Cash Flow

Part Five: Effective Cash Utilization

Throughout this series, we've covered why cash is king, what a cash flow statement is, how to read it, and how to forecast it. Now, let's tackle the million-dollar question (sometimes literally): how do we effectively use the cash we have?

How Much Cash is Enough Cash?

The goal is to build a cash balance that keeps the business secure and then manage that cash balance to maximize cash generation long term.

Security is approximately defined as 3-6 months worth of operating expenses.

For example, if my business has $10K per month of expenses, I would want a $30K-$60K worth of cash on hand (3-6 months of expenses).

How far you are to three or six is largely a matter of preference. If you're conservative like me and your business is young and/or prone to seasonal swings in revenue, you'll want to be closer to six months ($60K).

If - on the other hand - you're more aggressive and/or the business is more mature (3-5 years of sustainable operations), you'll be just as comfortable with three months ($30K).

Any less than three months, and you're just begging for trouble to find you. COVID is a great example of this. Any more than six months, and you run the risk of deploying your cash inefficiently. In other words, just having your cash sit there and not be either a) producing more income via a security like stocks or b) being reinvested in the business to expand operations is by definition a waste of your money.

Suppose I only need $60K but I have $200K. This means, I have $140K of "excess cash" (a wonderful problem to have). If I want to maximize future cash flow, maybe I hire a crew and a new truck to expand my market and sell more services. That $140K today is an investment in future operation cash flow.

Think of this as a two step process in cash utilization:

• Step One: Ensure you have a 3-6 month emergency fund

• Step Two: Make strategic bets with anything above your emergency fund to maximize future cash flow

For small businesses it may take you a while to get to that part two or part two may never occur or you may not want it to occur.

How Do We Squeeze as Much Cash as Possible Out of the Business?

Ok, now that we know how much is "enough" cash. Let's discuss how to squeeze as much cash as possible out of the three areas of cash flow.

Operations

The strategies here are pretty simple:

1. Increase Profitability

2. Minimize the amount of time between invoice and collections

3. Maximize the amount of time between when you're billed and when you pay vendors

Sure, we would all love to just snap our fingers and increase profitability, but this is your job as a business owner. Think strategically about how you are going to increase revenue and minimize expenses.

The other two strategies I refer to as "Working your Working Capital." Working capital is defined as Accounts Receivable (how much customers owe you) and Accounts Payable (how much you owe your vendors).

Working your Working Capital

How do we work these two areas? Payment terms have entered the chat.

On the receivables side, we want to have as small of terms as possible. Look at your customers. How many pay upon receiving the invoice? How many have payment terms where they don't have to pay you for 15, 30, 60, or even 90 days? We want to get these terms as low as possible. In B2C businesses like retail this is likely already happening. In B2B businesses such as wholesale or consulting this is much more difficult.

If you're in the latter camp, I typically find success by offering a "pay early discount" where you offer a 10% discount if you pay before the invoice due date. You could also threaten late charges for customers that pay after the due date. I typically find that carrots work better than sticks in order to maintain customer retention and a healthy overall relationship.

On the payables side, you likely have a lot less leverage. You are incredibly reliant on your suppliers and they have their own businesses to run. Therefore, they're going to be highly unlikely to give you terms longer than what is already in writing.

So, here you take what you can get and you do your best to extend terms as much as possible at the beginning of the relationship. If they offer 30 days at first, counter with 60. You could also offer a deposit in exchange for lengthier terms (pay 10% today and pay the rest in 60 days).

Investing Cash Flow

This bucket is primarily for reinvestment in your business through two primary areas:

1. Investment in expanded operations

2. Park unutilized cash in investments that outperform the market

In the first scenario, you want to spend cash with the intent of making more money in your operations. There are a number of ways to project these kinds of investments using Payback Period and Return on Investment (ROI) analysis.

For example, I just did this recently with a business development investment. I hired a firm that came in and built out an end-to-end customer acquisition program. They helped me identify ideal clients, write outreach messaging to cold contact potential clients, and then coached me on how to land them. They charged me $9,000 for this service over three months ($3,000 per month).

They helped me land two additional clients each of whom I charged $250/hr for roughly 15 hrs. per week worth of work.

So, I expanded my operation by $15,000 (15 hrs x 4 weeks x $250/hr) per month or $180K per year. My cash outlay for that expansion was $9,000.

My payback period = $9,000 (initial cash outlay) / $180,000 (annual cash inflow) = 0.05 years or 0.6 months (roughly 18 days).

I'll take that kind of bet all day long.

Another way to look at it is that my marketing investment generated a net gain of $171K ($180K - $9K). My Return on my $9,000 investment = 171,000 / 9,000 = 1,900%.

I'm not saying that these results are typical, but this is an example of how I utilize cash within my own business to maximize future operations.

If you're not in a position to make investments like this, it's also effective to simply work with an investment advisor to park unutilized cash in securities like stocks and bonds to generate returns higher than a bank account. Just make sure you don't put any of your 3-6 month emergency fund in these securities because it'll take time to liquidate those assets and convert them to cash so that you can actually access it.

Financing Cash Flow

Now I'm relatively averse to debt, but equity is also extremely difficult to raise, especially if you are fledgling business. I typically advise clients against getting into debt beyond simple lines of credit because the kinds of bets you'd be making with those funds are pretty risky and if they don't pan out you're going to be out more than just the cash behind the investment, you could even be personally liable.

However, there are times when financing makes sense. Here are some smart financing strategies that can help your business grow without putting it at risk:

Debt Financing: Use It Wisely

If you do pursue debt, consider these options carefully:

• Short-term lines of credit to manage seasonal cash flow fluctuations

• Equipment financing where the asset itself serves as collateral

• SBA loans which typically offer more favorable terms than traditional bank loans

Remember: Only take on debt that directly contributes to cash generation. The debt service payments should be comfortably covered by the additional cash the investment will generate.

Equity Financing: When It Makes Sense

Bringing in equity partners means giving up some ownership, but it can be the right move when:

• You need significant capital for rapid expansion

• Your business model requires substantial upfront investment before generating returns

• You would benefit from the expertise and connections investors bring

The key is finding partners who share your vision and timeline. I've seen too many entrepreneurs take money from investors with misaligned expectations, leading to painful conflicts down the road.

In the final part of this series we will bring everything together into a cohesive cash flow management strategy.