OCEAN CITY – Small businesses share an important parallel with the human body, Lawrence Gelburd tells his entrepreneurial classes at the Wharton School at the University of Pennsylvania: the need for liquidity.
"The No. 1 source of death in people is lack of blood flow from cardiovascular disease," says Gelburd, who is also an independent management consultant. "The No. 1 cause of failure of small companies is lack of cash flow because they’ve underestimated the amount of cash they need."
Of course, even highly successful companies can suffer a lack of liquidity, especially when they’re growing quickly, or the economy is struggling, or new taxes or legislative measures are cutting into their profits. But having a strategy in place — whether it entails making efficient use of credit or bank loans, or putting aside enough vested capital in advance — can help them keep running during a downturn or an emergency. What’s more, doing so can allow companies to take advantage of strategic opportunities.
Every business needs cash for emergencies, but the amount of liquidity your company needs depends on your industry type, the current economic climate and risks that may be unique to your situation.
"Business owners should calculate how much cash they would need to keep running if they encounter an internal emergency, such as all the company’s computers getting hacked, or an external adverse event, such as the loss of a major supplier or customer due to economic circumstances," says Gelburd.
A good place to start may be examining your "burn rate," or the amount of cash you need each month to cover your operational costs.
Cash reserves that function as an emergency cushion or a strategic fund should be easily accessible. "If an unexpected downturn in your business puts your payroll in jeopardy, you want to be able to quickly convert an investment into cash," says Fiol.
You may also want to consider stretching your company’s short-term liquidity by altering your business practices.
"Consider putting more of your expenses on a credit card," advises Robert Chalfin, lecturer at the Wharton School and a small-business consultant and author.
To avoid interest payments, "it’s crucial to pay off the balance each month, but you’ll gain 30 to 45 days of extra cash flow by drawing out your average monthly payments." Chalfin also recommends negotiating longer payment terms with suppliers while shrinking receivables by asking customers to pay earlier. And always do your homework and consider alternatives: Get competing bids every year on your employee health plan; investigate whether a bank loan is less expensive than supplier financing; or consider leasing.
"Business owners often initially ignore liquidity problems because they believe that the situation will resolve itself next week or they fear that lenders will pull the plug on them," says Gelburd. "That’s a mistake. Keep lines of communication open to give lenders and suppliers the flexibility to help you work out a solution before it really is too late."
During more robust economic times, small businesses are able to rely on available credit and loans to help keep their businesses running, "making them look, in some cases, much healthier than they really are," says Fiol. "Today, sound business principles and good cash management practices and analysis are more critical than ever, which, ultimately, can potentially strengthen small businesses and give them staying power."
(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)