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The Liquidity Rule Every Business Owner Should Know

Every business owner understands that cash/liquidity is critical to running our business. But, knowing how much cash is needed leaves many business owners confused, frustrated, and sometimes losing sleep. It takes a guide to help us know how much cash is needed. Often, we hire an accountant or controller to keep track of cash. Some may hire a part-time CFO or business coach to help them. Every business deserves a business with a strong financial future and healthy cash flow and cash balances. 

Growth in a business always requires cash. I have worked with several professional services firms, and one in particular was a practice with 3 locations. Their revenue came from professional services that were reimbursed by insurance. Insurance companies are notoriously slow and this practice found themselves with at least half of their receivables over 90 days. No one was accountable for collections and they were forced to borrow from very expensive lending sources to fund payroll. Very quickly, we put the internal accountant in charge of collections and she blocked time on her calendar daily to make collection calls. In the next 6 weeks, the amount of over 90-day receivables was reduced to about 10% ($100,000 cash impact) and the firm’s cash balance doubled. They no longer had to borrow and saved a significant amount of interest expense.   

I worked with another firm in the manufacturing space. Their typical terms were net 30 and incurred all the material and labor costs up front and got paid after the product was shipped. I recommended we consider asking for 50% deposit up front to cut the cash outflow in half and bill the remainder when the product was shipped. At the time, this firm was generating $10-12 million in revenue, so this step reduced their cash outflow by as much as $500,000 per month and increased their cash balance with those deposits and cut their receivables balance in half. 

So, how much cash is enough? Looking at thousands of businesses in banking and coaching careers combined, I’ve concluded that about 15-20 days sales is a good number. Take your annual sales and divide it by 360, then divide that number into your cash balance. If you have $5 million in annual revenue, that’s about $14,000/day. To have 15 days sales in cash, your cash balance would need to average $210,000. 

If you’re struggling with liquidity, work with your finance person to find out how to improve your cash balance and take action. 

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