In the article, author Robert Seiwert poses seven true/false statements to help you evaluate the quality of your relationship with your bank. The purpose of this evaluation is to determine whether your bank will continue to “be there” for you, in terms of providing financing when you need it, giving you competitive pricing on financial products and services, and offering you guidance and support as you set out to achieve your business goals.

The premise of the article is interesting enough: one means of protecting your bank funding is to woo your banker, in the figurative sense. Your banker wants you to be a stable and committed business partner, and it’s up to you to prove that you fit that mold. If you aren’t making the desired impression, you will see your banker become distant and non-responsive — like a bored spouse who’s wondering if there are other, more exciting fish in the sea.

The metaphor could be fodder for a lively happy hour conversation, but that may be where the usefulness of Seiwert’s advice ends (sorry, Mr. Seiwart). You see, Seiwart concludes his commentary without any practical recommendations for the small business owner. The grand conclusion is to “seek a bank that rewards a relationship approach to doing business with them.” Here’s my problem with this advice. Establishing a relationship with a banker is like establishing a relationship with anyone else. You don’t really know the limits of that relationship until those limits are tested. You may answer true to all of Seiwart’s statements, but when your business fundamentals worsen, the dynamic of the relationship will change — no matter how great you think that relationship is. Taking the metaphor one step beyond good taste: if your business was lean and mean when you and your banker hooked up, you can expect the flame to die out when your operations get fat and bloated. And no amount of “talking it out” is going to change that.

So what is the solution for small business owners? The simplistic answer is to manage your business as if your life depends on it. If things start going sideways, identify the problems and start brainstorming solutions immediately. You might consider hiring someone to help you, realigning your business focus, overhauling your supply chain, and yes, asking your banker for feedback on those prospective actions. The worst possible thing you could do is nothing. In business, waiting is synonymous with dying.

The point that Seiwart fails to make is that it’s not enough to go to your banker with your problems. You should, instead, be going to your banker with solutions.

You can read the first four articles in the ABA’s series on small business lending here.

Having interacted with a fair number of small business owners, I can tell you: there aren’t enough entrepreneurs out there actively managing the cash in their small businesses. In good times, the “come what may” cash management strategy probably works out just fine. But in bad times, when customers are closing their wallets and vendors are raising their prices, a reactive approach to cash can kill you.

So what’s a small business owner to do? When you want to know what’s going on with your business’s cash flow, now and next week, next month or next year, you need to get a cash flow model. By cash flow model, I mean an set of working, interactive financial statements that allows you to test the impacts of various sales and spending scenarios. If you know how to link up your balance sheet, income statement and cash flow statement, you can build a cash flow model in any spreadsheeting software like Excel.

Alternatively, you can download our small business cash flow model absolutely free. Just provide your email address (see the box to the right) and we’ll send over the download information.

Having a cash flow model spares you the tediousness of continually assessing your cash balance, your expected cash production and your expected cash outlays. You can input your assumptions with a few clicks and then watch how the cash balance adjusts. With our free small business cash flow model, any projected cash shortfalls are funded with an increase to the revolving line of credit.

Managing sources and uses of cash

At the end of every reporting period, your business’ cash balance reflects the net impact of various sources and uses of cash.

Common sources of cash include:

• Asset sales
• Declines in accounts receivable
• Declines in inventory
• Increases in accounts payable
• Net income plus depreciation and amortization (net income is the net of sales and expenses, but you add back the depreciation and amortization because these are non-cash expenses)
• Increases in debt
• Stock sales
• Owner contributions
• Receipt of loaned funds

Common uses of cash include:

• Asset purchases or upgrades
• Increases in accounts receivable
• Increases in inventory
• Decreases in accounts payable
• Net losses plus depreciation and amortization
• Debt repayments
• Stock repurchases
• Owner distributions/dividend payments

Most people can’t keep track of all these moving parts in their head or even on a sheet of scratch paper. But if you have a cash flow model, you don’t need to. Just plug your numbers into your spreadsheet and watch your cash balance move up or down accordingly.

You will want to use your cash flow model to project your future cash balance when you have large cash expenses, such as payroll, debt repayments, lease payments, capital spending, and seasonal inventory build-ups, on the horizon. But you can also use a cash model to test the impacts of:

• Rising sales
• Falling sales
• Increases/decreases in accounts receivable
• Increases/decreases in inventory
• Increases/decreases in accounts payable
• Early debt repayments
• Changing expenses
• Taking advantage of 2% 10/Net 30 discounts

Being able to test a multitude of different scenarios might inspire you to make very positive changes in the way you run your business. For example, you can decide what it’s worth to you to optimize your accounts receivable collection procedures or to change your inventory-buying schedule. And, once you start implementing changes, you can then use your cash flow model to test your actual performance against your projections — an exercise that ultimately makes you better at predicting how various factors affect the financial health of your small business.

Which of the following is an ongoing source of repayment for your small business credit line?

a. Your equity
b. Your accounts receivable

Which of the following is a source of cash?

a. Rising inventory
b. Rising debt

If you had to think too long to answer those questions, you might need a little refresher course on cash flow. You see, your small business will live or die on cash flow. You can manage through periods of negative profitability, but you can’t manage through extended periods of negative cash flow. When the cash dries up, you can’t pay your rent, you can’t pay your employees and you can’t buy inventory. You also can’t get a small business loan or an increase to an existing small business line of credit. Your banker will take a quick look at your negative cash flow performance and say “no thanks,” without even blinking. Think of cash as the oil that greases the gears of your business. Without cash, your small business comes to a grinding halt.

So let’s start at the beginning. Cash flow is the change in your cash balances over time. If you have $1000 in your small business bank account on January 1 and $1500 on January 31, you had positive cash flow of $500 for the month. Cash flow is always measured relative to a period of time. This is different from cash on hand, which is measured as of one specific point in time.

Cash flow is typically discussed in terms of sources and uses. An increase in liabilities, for example, is a source of cash. But an increase in working capital accounts is a use of cash. If those relationships don’t immediately make sense to you, think back to the basic accounting equation, assets = liabilities + equity. When you make a change to one part of the equation, you have to make a corresponding change to keep the entire equation in balance. If your liabilities increase, you must have a corresponding increase in assets or a corresponding decrease in equity. Since we are talking about the cash impacts here, increased borrowing is a source of cash. And this makes sense: when you borrow money, you have more debt and more cash.

So what happens to cash when your working capital accounts, like accounts receivable and inventory, go up? Cash, accounts receivable and inventory are all assets. If some assets go up, others must go down. Increases in accounts receivable and inventory, therefore, are uses of cash. This is a crucial point to understand when you are running a small business — because you can improve your cash flow performance by more efficiently managing your working capital. Improved cash flow performance means you have more money to pay your bills and invest in growth.

Back to the quiz above, the answers are both b. You repay your small business line of credit with cash produced from your accounts receivable. And rising debt is a source of cash.

Our next discussion will address cash flow management in more detail and talk to the importance of having a cash flow model for your business. Once you have one, you’ll wonder how you ever managed without it. Have small business questions? Send them to us at questions@businessmorgue.com.