During the spawning stages of the company life cycle, the small and emerging business owner must focus on survival and flash (hyper, high-impact) growth. Managing cash flow and working capital is imperative. Throughout the company’s evolution it will be forced to deal with capital management strategies (equity and debt) and other aspects of the balance sheet that will dictate its success. The small and emerging business owner must become accustomed to developing and implementing balance sheet strategies and initiatives to position the company to handle the challenges of future life-cycle milestones. The task of fine-tuning the company’s balance sheet is never ending, especially when the business environment and the business itself continue to change.

One temptation for the small and emerging business owner is to focus exclusively on the P&L, maximizing revenue and minimizing costs. The balance sheet speaks volumes about the health of the company, although it does not receive as much attention as the P&L. Balance sheet policies yield more subtle results that, if implemented properly, will sustain the organization indefinitely. Novices may feel that balance sheet policies/issues seem too esoteric to manage. The executive/ business owner skilled at evaluating the company’s health, however, will attest to the fact that the balance sheet never lies. Some argue that balance sheet strategies tend to be more defensive and less proactive in nature than P&L strategies. Balance sheet strategies typically have a mid- to long-term time horizon when it comes to payback. For this reason balance sheet strategies must be prospective to be of any use. The impact of the balance sheet on cash flow and earnings prompts attention to two areas that must be handled proactively—working capital (current assets and current liabilities) and debt.

Knowing how the balance sheet will serve analysis needs is essential in keeping up with a balance sheet maintenance plan. A good place to start balance sheet management is by focusing on working capital. The goal is to optimize certain elements of working capital and, in turn, maximize cash flow. Optimizing the dollars tied up in receivables, inventory, and payables means more cash available for investing in the business.

The company’s ability to manage cash flow is the true indicator of short-, medium-, and long-term survival. The short term is the most critical time frame for the small and emerging business; therefore, establishing discipline in cash flow management via working capital models now will benefit the company as it grows. Knowing this, managing these areas of the balance sheet is critical:

- Accounts receivable. Are customers paying? If so, how long does it take to collect? Days-Sales-Outstanding (DSO) is a frequently used metric for evaluating overall collection efforts. The DSO calculation (dividing the receivables balance by a daily average revenue number) will give small and emerging business owners an idea of how long, on average, they are waiting for customer payments. Making this analysis meaningful depends on the company’s understanding of cash flow needs. It may be able to budget revenue to some degree, but how about predicting cash flow? The company needs to understand how long it can reasonably go without customers paying. Management also must understand the averages for thismetric in the industry. Perhaps cash needs trump that of industry averages. The industry may be so new that no averages exist. If this is the case, the company will need to analyze liquidity needs (i.e., payroll, vendors, debt service) along with projected revenue targets and develop time horizons for receiving cash payments on sales. Depending on the industry, 30 to 60 days is a fair collection period. If collection efforts go into the 90- to 120-day range, red flags begin to go up; anything over 180 days is generally unacceptable.

- Inventory. Managing inventory is crucial to good cash management, especially for the retail and manufacturing sector. Idle inventory sitting in warehouses  or  storerooms  could  be  cash  used  for  paying  bills,  funding expansion, and the like. The inventory turnover ratio (i.e., inventory turns) is a strong metric for evaluating effectiveness in inventory management. Inventory turns (i.e., dividing total cost of sales by the inventory balance) will yield the number of times the company turns its stock of inventory. Slowmoving inventory (i.e., a low number) indicates excessive inventory levels. Managing inventory in a retail environment is fairly straightforward (the company has either overordered/undersold,  or  oversold/underordered); however, inventory issues in manufacturing environments can be more vexing. Supply chain issues, purchase price, and manufacturing variances all have an impact on inventory balances. How about customers; are they flexible with inventory delivery terms? Do they take delivery in a reasonable amount of time? Devising sound guidelines for inventory management and accounting will help control inventory and its impact on cash balances. The first step in managing inventory is to perform reliable analysis. Capturing, valuing, and analyzing inventory balances will position the organization to maximize cash flow and liquidity.

- Accounts payable. How quickly is the company paying bills? One might think paying bills as quickly as possible is good from a discipline standpoint, but a company needs to hold on to cash as long as it can. This is especially true for a small and emerging business that needs to have as much cash available as possible to fund growth. Working out terms with vendors is standard. A window of 15 to 30 days to pay bills is standard. Depending on the clout the business has with vendors, this may stretch to 30 to 60 days. Pushing for payment terms, however, has its down side. Vendors get wise to customers who push the envelope in this area and often increase the price of the product to offset the risk they experience in waiting for payments. It is important to note that the company’s payable to the vendor is the vendor’s receivable from the company. Just as the company is trying to shorten the time period that receivables are outstanding, so is the vendor. A firm but reasonable payment policy works best when it comes to managing accounts payable.

- Liquidity ratios. Measuring liquidity is an ongoing concern for growing businesses. Keeping tabs on liquidity ratios and debt-to-equity ratios is important especially when complying with loan covenants. Monitoring these ratios will help management assess immediate needs for running the business or predict future needs in the case of expansion or divestiture. The organization is best served to understand liquidity ratio benchmarks for companies in the same industry and measure itself against them.