Small business owners often overlook the most important aspect of financial management in their businesses: Cash. Though often overshadowed by the topics of capital budgeting (deciding what long-term assets, like machines and buildings, to purchase) and capital structure (deciding how to finance these purchases), cash management is actually more important from at least one perspective: If you run out of cash to pay your bills, you will go bankrupt. Period.

Accounting numbers do not help small business owners recognize their perilous cash situations, either. Sales are recorded in the books, whether or not cash is received. If a firm makes most of its sales on credit, it can appear to be quite profitable from an accounting perspective but still be cash-poor. Firms with positive net income can and do go bankrupt — when they run out of cash. Firms with chronically negative net income can and do continue to operate. All these firms have to do is convince uninformed investors to buy their newly issued stock or to loan them money. Example: Sears. This scheme is unlikely to work for your small business, however.

So what is a small business owner to do? Spend some time developing what we call a cash budget. Look at the next four quarters and try to estimate your cash inflows and outflows. Use history as your guide, and do not assume you will suddenly develop new fiscal restraint. Use these estimates to figure out what the net change in your cash position will be in each quarter. Now, take your current cash balance and start adding (or subtracting) the changes forecasted in your cash budget. If the quarterly change is positive and your previous cash situation was solid, great! However, if the change in a quarter is negative, determine whether that change will reduce your cash balance below a safe level for your firm. Be conservative when determining how much cash represents a safe level. How often do you have pleasant cash surprises versus unpleasant cash surprises? Sadly, windfalls are rare, but unexpected expenditures are all too common — the delivery truck breaks down, an employee gets injured, or a fire destroys part of your inventory.

What should you do if your forecast shows your cash dropping below a safe level? Visit with your banker. This person has probably already loaned you money and, therefore, has a vested interest in your firm’s survival. If the low cash balance is a result of a temporary situation, like taking on inventory in preparation for a large project or sale, then a short-term loan might be the appropriate fix. If your forecasted cash shortage is caused by the purchase of a long-term asset like a new pizza oven, perhaps a long-term loan would be more appropriate. In either case, preparing the forecast in advance is important because doing so allows you to tackle problems in advance instead of waiting for a cash crisis to arise before taking action.

A native of southwest Missouri, Dr. K. Stephen Haggard is an associate professor of finance and a BancorpSouth endowed research professor. His teaching and research interests include corporate finance and asset pricing.’

This article appeared in the February 2, 2017 edition of the News-Leader and can be accessed online here.