Growth requires additional capital

Editor’s note: This is part two of a series about cash flow.

As sales increase so does the amount of cash necessary for operating the business. This can be estimated by using a cash-to-sales ratio. If average cash balances of $100,000 were needed to maintain $500,000 per month in sales, then $150,000 would be needed if sales increased to $750,000 per month. 

Accounts receivable also can be expected to increase as sales volume increases. However, prudent management of receivables will control this factor, i.e. financed transactions discounted promptly, cash jobs on progressive payment and collected promptly – and all jobs requiring deposits.

As sales rise so do accounts payable. So, if 30 days payables outstanding is normal, a monthly sales increase from $1 to $1.25 million may increase payables by $25,000 to $50,000. As a well-run company establishes credibility it presents an opportunity to get “terms” from vendors, which enables it to grow and to pay some suppliers on a monthly basis. Most successful companies also find a method to get their jobs installed rapidly, and if these jobs have been sold properly cash flow increases. 

One of the often self-imposed hardships is that small business owners do not know how to measure their cash needs. When their accountant completes the year-end tax return, they come to the startling revelation that net (pretax) profit is seldom all cash. It often is composed of inventories, accounts receivable, marketing and sales advances, equity in equipment and similar forms. Often it is a shock to owners of small businesses to find their companies have made money and there is little cash to meet the needs of paying taxes. Frequently, these same companies during the year manage purchases against checkbook balances, which is unwise because it does not include immediate payables or forthcoming personal tax liabilities. Here’s an example of a suggested monthly cash summary report.

To download a sample cash summary report, visit

Additional capital issues

Companies with large marketing budgets and those that advance a portion of the commission upon approval will have cash depletion based on their investment in the backlog. Backlog (business that is sold and approved for installation or waiting to be scheduled) usually contains some advances for labor and material as well as marketing expenses and advances to salespeople as well as overwrites to sales management. All of these deplete cash. Here’s an example of a fairly good-sized specialty company that sold products such as roofing, siding, insulation and windows. 

Backlog                    $1 million
Marketing Expense            15 percent
Commission, overwrite advances    7 percent
                    22 percent        

Estimated investment in backlog    $220,000

How much cash do you need?

To better define working capital, here is a simplified yet eye opening exercise on working capital needs. It is constructed in a basic format and does not contain factors such as inventory, depreciation schedules or capital investments.

A. Annual Revenues                        $_________ (A)
B. Anticipated Net Pretax Profit (%_____) after all expenses    $_________ (B)
C. Subtract B from A = C                         $_________ (C)
This approximates the total expenditures and estimated cash needed to produce the net profit.

Using a single product as an example (windows, siding, cabinet facing), indicate the number of weeks it takes to process a contract from the time it is sold until the time it is installed (completed). For example, let’s choose six weeks. Next, using a 48 week year (52 weeks less vacation and other non-operating days), divide the above number of weeks (6) into 48 to achieve your turn ratio.

48 ÷ 6 = 8

Next divide the figure in (C) above by 8 (your turn ratio).

$ ___________  ÷  8  =  $ _____________*
* In a basic way, this represents the amount of money necessary to operate the business.

Note: Remember to review the segment “Understanding your balance sheet” in part three of this series.