The importance of tracking your cash flow. Good monitoring, spurring prompt payment are vital to clinching profits

Jessica Lipnack admits she made a mistake when she first took out a loan to pay for a direct-mail membership drive for her networking directory business. ``I went to the bank and borrowed the whole amount,'' says the president of Networking Institute Inc., a young West Newton, Mass., firm that publishes specialized directories for social service organizations.

But the bills for the printing, postage, and mailing came in at different times. And all the time the money she borrowed was pulling interest. She could have asked for the money in increments just before each bill was due.

These kind of decisions come out of cash-flow analysis. The loss here was relatively minor (a few weeks' interest), and Ms. Lipnack noticed it right away by paying attention to cash-flow details. But many other small-business owners -- some of them relatively sophisticated -- don't really track cash in and out of their business on a regular basis. They don't really know what's happening with their business cash.

``You can have a profitable year and go out of business,'' says Jan Zupnick, president of the Entrepreneurship Institute of Columbus, Ohio, simply by running out of cash to cover your bills. This is especially true in the growth phase, adds Mr. Zupnick, whose nonprofit institute holds community seminars on entrepreneurship.

If you are shipping a lot of products, you may not realize those customers that were to pay you in 10 days are actually paying 30 days later. Or perhaps you estimate your late-payers or no-payers at 2 percent of all receivables, and the actual rate is 5 percent.

That can be a problem if you're counting on that money to buy the larger and larger inventory demanded by fast growth. The possible loss of opportunity is a high price to pay for not having a cash-flow plan. Some businesses have literally grown themselves out of cash -- and out of business.

The solution?

A little planning near the start-up phase can avoid problems down the road.

Have a plan for handling receivables (money owed to you by customers). Offering a 2 percent discount for payment in 10 days pulls that cash in when you need it most -- right away. Find out a realistic estimate of how long other businesses in your area carry receivables by getting in touch with your industry trade group. Names of trade groups can be found in the Encyclopedia of Associations, available in any major library.

Develop a relationship and set up a credit line with your banker ahead of time -- before you need the money. Money is most easily obtained when you don't need it. You can ask for money to finance your receivables or your inventory.

When a business slips, the first area to suffer is advertising, says Raymond Mullaney, president of Capital Planning and Services in Topsfield, Mass., which aids small businesses with financial planning. And that shouldn't happen. If the business has a credit line, the business person doesn't exhaust his cash to meet the payroll. Then the advertising budget is not driven by the cash available.

This is a very good time to have your business plan (see May 21 article) in hand. If you have planned and know how much money you will need and when you will need it, you will reduce unpleasant surprises.

``Work from a cash budget,'' says Richard W.Ramsburg, who markets a cash-management program for small businesses for The Travelers Companies, the big Hartford, Conn., insurance underwriter. Add the cash on hand to all fully liquid assets (anything like a savings account from which you can get cash instantly). Add all receivables (money due you) that you estimate will be paid in that month.

From that total, subtract the cash that will be paid out that month: salaries, rent, loan payments, taxes, and utilities. Focus only on the exact amount you will shell out during the month.

The total is your projected cash position for the month.

Most accountants don't prepare cash budgets for their clients, says Tony M. Ettinger, also of Travelers. It's something the small-business owner should do, he says. Accountants normally prepare the balance sheet: a list of assets and liabilities, along with income statements, showing sales and the costs of sales, he says, but they don't show the flow of working capital and changes in assets and liabilities.

In other words: They tell you what you have and what you owe, but not whether you will be short of money next month.

Do projections (estimates) for each of the next 12 months, says Mr. Ramsburg. Then identify months that you will have less than a comfortable level of cash. A rule of thumb for a comfortable cash position is two to three months' worth of cash paid out, depending on your business.

What if you forecast out six months and find you need a loan four months from now?

Knowing that, Mr. Ettinger says, you can go to a bank and bargain for a good rate -- and obtain a loan that meets your needs, not the bank's.

For example: You find you will need $100,000 for three months. At the end of that seasonally slow period, you believe sales will pick up so you can pay it off. Look for a loan that will have no prepayment penalties and very low or no payments during the first three months.

By knowing exactly what you need, you can tailor the loan to fit your situation.

Forecasting months ahead has another advantage. Knowing that some months you will be cash-rich, you can be prepared to invest the surplus, says Ramsburg. That's the advantage of cash management systems like those offered by Travelers, banks, and some financial advisers.

Cash management programs usually include money-market funds, credit cards, and unsecured credit lines.

One advantage of the financial planning systems for small businesses, says Richard North, president of North, North & Nelson Inc. of Boston, is their concise reporting statements with all transactions itemized. Mr. North, who sells cash-management systems to businesses, says a monthly statement forms an easy-to-read record, which can be used to track past -- and project future -- expenses and income.

It takes a little time -- one expert estimates about one hour a month -- but keeping track of your cash flow can pay dividends in peace of mind for the small-business owner. One such owner found she was actually working too hard, that her business had more than enough cash flow to sustain it, and that she could take a vacation she had been longing for.

A Monitor series. Next: marketing your business.