The maxim "Cash is King" is far more than just a cliché. Today's financial headlines are a stark reminder that cash is indeed the life's blood of any enterprise. For some businesses, cash requirements and cash management are relatively easy to understand and predict.

For other businesses however, the ebb and flow of cash can cause the business owner great anxiety. Why, throughout history have there been so many businesses, which are profitable on paper, but unable to pay suppliers, staff and meet other obligations?

From a cash flow accounting perspective, businesses collect and recognise revenues from one of two perspectives: cash based and accrual based.

With cash-based systems, the goods or services are paid for immediately during the transaction and there is no time lag between the transaction and the payment. With accrual-based systems, there is a time lag between the sale of a good or service and the collection of payment.

In addition to the cost of financing the customer, there is risk of non-payment even though the customer already has possession of the goods or services performed. An example of a cash based system is a grocery store: you don't leave the store without paying for the items purchased. Even if you pay by credit card, the grocery store collects payment from the credit card provider. Whether or not you pay your credit card obligation, the grocery store's revenues are not at risk.

A good example of an accrual-based business is any business that gives credit. For example a plumbing company will normally perform the service requested by a customer and then invoice them after. The company has assumed the risk of non-payment as well as the cost of financing the customer's payable. In essence, if the customer owes the company $1,000, while that invoice remains unpaid, the company loses the opportunity cost of investing that $1,000.

Estimating cash requirements for a cash-based operation is fairly simple. First, you examine the Operating Statement (P&L) and determine the average monthly cash needs.

Figuring monthly average cash requirements

Operating Statement: January 1 -December 31, 2009

Revenue: $ 675,000

Cost of Goods sold: $400,000 (.593) = $33,333 average monthly expense

Gross Profit: $275,000 (.407)

Gen & Admin: $200,000 (.296) = $16,666 average monthly expense

Profit: $75,000 (.111)

Total monthly average operating cash requirement: $ 50,000

If you are forecasting increased revenues in the future, just plug in the numbers and use the same expense control percentages (. 593 and .296 in our example) to find the estimated future monthly average requirements.

Estimating cash requirements for an accrual-based business however will generally require the efforts of a good book-keeper and a financially literate business owner/manager.

It is difficult to over-emphasise this, particularly for rapidly growing businesses, as it can be the difference between business success and failure.

How much operational cash should you have?

A rule of thumb is that businesses should have at least two to three months of operating capital available in case of emergencies. Some businesses will in fact maintain a standby line of credit, which may go untouched for years. For cash businesses, having a line of credit is a nice thing to have, for an accrual-based company, having a line of credit may be essential.

In closing, if your business is in good financial shape and your company has excess funds, it is always good to keep at least two months of company assets that are extremely liquid.

Murphy's Law is always lurking and finding yourself short on cash is the most stressful situation a business operator can experience. Always know what it takes to carry on operations and when it's time to be concerned. Long before it actually might happen.

Asgill Post Ltd. provides assistance with Business Valuation, Financial Strategy and the Purchase and Sale of Companies. For comments or queries, contact Kumi Bradshaw MBA, CBA, BVAL via email at kumiasgillpost.com or phone at 295-3301 Patterson Partners Ltd. provides cross-border tax, estate and investment planning services to dual citizens of the USA and Bermuda, their families and businesses. For more information, visit www.patterson-partners.com or contact Jennifer A. Patterson, CFP®(US), CIMC, CIMA®, TEP via email at infopatterson-partners.com or phone 296-3528.