In a recent networking event in Northern Virginia, Phillip Merrick, co-founder of webMethods, said that while launching his company he got a list of "Don't Do Rules," and one of them was "Don't run out of cash."

On the lighter side--to emphasize his unconventional way to start his business--Merrick said that his founding team broke almost all of those rules (well, technically not the 'Don't run out of cash' rule--they got down to their last $31). To address the problem of a $31 bank balance while having a $30,000 payroll, Merrick said that they concentrated on selling the software and found that selling software is much more fun then giving out equity in the company to investors.

Why Should You Manage Cash Flow?
Humor aside, maintaining a positive cash flow is critical for the survival of a business. You need to understand the sources of your cash inflow and outlets of cash outflow. You need to have a good idea of their timings, too, so that you can identify potential cash flow problems and arrange for funds to address them.

We all know that profits equal income minus expenses. A corollary of this is that if your expenses are more than your income, your business would not survive. Cash flow, on the other hand, is the movement of money in and out of your business. This is more critical then profits because having more income than expenses does not guarantee that the money would move in right sequence--first you get paid (income) and then you pay (expense). If the cash flow timing is not good, then it may create a negative cash flow at the wrong time, which would limit your options or (worse) could jeopardize the existence of your company.

Profits Alone Can't Keep a Company Afloat
Even a profitable company can go bankrupt. Let's say you sell an item for $1,000 and it costs you $600 to produce it--a profit of $400. Out of the $600 cost of goods, you need to pay $300 to a vendor (and you have to pay within 15 days after you receive the goods). Let's say that it takes you three days to make it and that you get paid 60 days after delivering it. This means that 45 days after paying to your vendor, you would get paid by your customers, thus creating a cash flow gap that, if not addressed properly, could bankrupt your business.

Cash Creates Options
For the first quarter of 2003, Cysive reported revenue of only $87,600 (compared to the $439,000 for the fourth quarter of 2002, and with more than $2 million in expenses). Despite having such a big loss, the company was able to create some options and recently merged with another company with the intention of going private because it still had $129 millions in cash.

Lack of Cash Brings Down High Fliers
In the later part of the '90s, the Ford Motor Company was awash with cash. It was sitting on more than $20 billion. Jacques Nasser became CEO and he was on top of the world.

Then Ford started to buy companies. In 1999 it bought Volvo for $6.47 billion and later bought Land Rover's SUV unit from BMW. Then it had to settle a number of lawsuits brought forward by governments and individuals. These were followed by the Firestone tire recall. In between, Ford closed some plants in Europe and laid off people.

Somewhere along the way Ford also failed to achieve improvement in its year-over-year results. At one time in 2000, its earnings fell by 33 percent from the previous year. The net result? In just over three years, its $20 billion war chest evaporated and it had to cut dividends by 50 percent to save $1 billion in 2001. The eventual outcome was that Jacques Nasser was no longer the CEO of the firm.

Positive Cash Flow Could Help You Keep Your Company
The current Ford Motor Company was Henry Ford's third company. His first two were mostly started by OPM, and he was primarily an employee. During those ventures, Ford was quite adamant about not compromising on his ideas, which meant that he wanted to bring out only the perfect automobiles. The net result was that those two companies did not create revenue streams early enough and folded.

The third company, started in 1903, was Ford's own company, giving him different feelings about its survivability. He realized that the only way he could keep it going was by getting regular cash--a point that convinced him to bring to market good automobiles (that may not, however, have been perfect by his standard, but brought cash in).

How Do You Manage Cash Flow?
How you go about managing your cash flow is critical. The processes and policies you institute determine whether you will have realistic cash flow management or not.

This is an area to which Alba Aleman and her management team at Cairo Corp paid extra attention. One of their critical success factors was to establish a strict cash flow management early on. They did not spend money before they received it and employed all sorts of creative mechanisms to quickly secure incoming payment and slow down outgoing payments. Cairo Corp's realistic, fiscally responsible mentality could be attributed to the fact that their's was a bootstrapped operation.

However, whether you bootstrap your company or use OPM (Other People's Money), you must have positive cash flow or you will not be able to keep your company for long. But efore you institute a cash management program and adhere to a discipline, you need to understand your cash flow.

Analyze Your Cash Flow
There are various components of your cash-flow pipeline that you need to analyze. Thorough analysis of these components will reveal the gaps between your incoming cash and outgoing cash, which will help you in devising plans to close those gaps. Some of these important components are:

• Account Receivables. Understand the trends or your AR. Know how they are aging and the industry benchmarks. Find any problem areas or customers.
• Credit Terms. The terms that you have with your customers and the ones that you have with your vendors have strong impact on the cash-flow gaps.
• Credit Policy. Analyze how you extend credit to your customers, how you qualify them and the risks associated with it.
• Inventory. Analyze both the raw material and finished goods inventory to find ways to reduce inventory needed to maintain and grow the business.
• Accounts Payable. What are the trends? How are they aging?

Institute Cash Management Process
Only after you have understood the gaps in your cash flow can you go ahead and devise a plan to address them. Your plans and strategies should be aimed at narrowing or closing the gaps as to achieve more positive cash flow.

Forecast Your Requirements
Develop long-term and short-term plans for your operating cash requirements. Consider all variables--income, expenses--and build cash-in/cash-out forecasts that go down to daily levels.

Control Your Expenses
Don't spend before you earn it. Keep an eye on all spending, demand justifications for all expenses, develop alternatives and choose the least expensive option. Keep overhead down--hire only when necessary and outsource when possible. You could refer to the following cost control philosophies of Ian MacMillan, professor of management at Wharton Business School:

• Never buy new what can be bought second-hand
• Never buy what can be rented
• Never rent what can be borrowed
• Never borrow what can be begged
• Never beg what can be salvaged

Collection and Payments
The objective of your credit terms with your customers and vendors should be that the net effect of them helps you create positive cash flow. Always find ways to delay payments to suppliers without jeopardizing the relationship and find ways to collect early from customers.

Secure More Funding Sources
Always push for more bank and funding facilities. Getting them is easier when the going is good and when you do not need them.

Manage Inventory
Inventory locks up capital--it is dead cash. How you manage it will seriously impact your cash flow. If possible, ensure just-in-time inventory.

Develop Contingency Plans
Never take your eyes off the ball--which is maintaining positive cash flow. Develop plans for good times and bad times. Ensure that there is always enough cash for operations.

Effectively managing and monitoring cash flow is one of the critical success factors of all business. Cash Flow Management is basically a timing issue. Without good timing, nothing worthwhile happens in life, and the same is true in business. Someone said that it is far better to be right at the wrong time--having cash in hand even though you are netting a loss--than to be wrong at the right time--having no cash even when you are profitable.

Strategic and results-oriented, Sunil is an entrepreneurial consultant who had founded a B2B ASP for the building & construction industry. He is the CEO of Cerebral Works Inc., a strategic management and technology solutions firm. He publishes a business and marketing planning  e-newsletter. An avid mountain climber and runner, Sunil has climbed Mt. Kilimanjaro and various peaks in the Himalayas and finished the Detroit Marathon. He holds an MBA degree from the University of Michigan, Ann Arbor, and a BS in Electronics and an MS in Mathematics from the BITS, Pilani, India. Voice: (703)-395-9812; E-mail: sunilsharma@cerebralworks.com.