Small businesses are often touted as the growth engine for most of the world’s economies. Although championed as the desired model for creating substantial job employment opportunities, and advancing key discoveries in technology and science, small businesses have barely exceeded a 50% rate of survival after 5 or more years of operations.

The reasons behind the failure of small businesses are as complex and varied as the millions of businesses which start up each year. There is pervasive evidence however, that lack of financial management and adequate cash controls play a significant role in the demise of small businesses.

In short, they run out of money.

This article focuses on one of the key pillars of strong financial management especially for consultants: Managing Cash Flow. Simply put, cash flow analysis examines the timing of the intake of revenues against the outflow of expenses. As a practical aid, Consultants must avoid the following four “traps” in managing their practice:

1. Lack of Headlights into Financial Performance:

Many consulting firms, especially sole practitioners, often relegate the task of financial management to a low priority ranking on their to-do list. Lead generation, sales calls and scouting new clients are often given higher priority.

Understanding financial reports such as cash budgets are important to providing early detection of potential cash problems requiring corrective actions. Small consulting enterprises should develop reasonable and conservative projections for monthly, quarterly, and annual revenue and expense.

Variance analyses should be conducted by line item on variances with +/- 10% deviation. Consultants should establish a balanced scorecard for their business to include cash flow measurement as a key metric of the health of their business.

Contingency planning and seasonality should be included in cash flow budgets so the business is poised to react quickly to downturns in the economy and possible reduced demands for services.

2. Poorly Managed Accounts Receivables:

The saying “cash is king” is a familiar refrain in the business world especially today given the recent financial meltdown on Wall Street. Small consulting firms have to implement creative ways to improve customer payment terms and cash collections. Incentives for early payments should be part of the terms and conditions offered to customers- especially those who comprise a significant percentage of the accounts receivable account.

Accounting software programs and technology should be implemented to flag any potential delinquent accounts and business owners must take swift actions to collect all outstanding invoices. Depending on the breadth of resources available, a small consulting firm may decide to out-source accounts receivable management and collections to industry professionals and specialists.

3. Heavy Investment in Non-Cash Bearing Resources:

Small consulting firms often allocate disproportionate amounts of money to expense items such as salaries, furniture, space, marketing collateral and operating expenses which tie up major chunks of cash which can be better used to either cover expenses or invested in interest bearing accounts.

4. Maintaining too much cash on hand.

Small consulting firms can often become too risk averse and maintain large amounts of cash which could be invested to earn a rate of return which could be used to weather changing business conditions. A good problem to have, of course, but a problem nonetheless.

Consultants must have a solid understanding of their business model in order to adequately forecast cash amounts which can be freed up to invest in instruments for the appropriate period of time. Consultants must balance requirements for liquidity with the opportunity cost associated with other options.

In the early stages of a consulting practice, it is important to remain as flexible and unencumbered as possible.

Consultants often experience these top cash flow problems when they do not adequately maintain a relentless focus on their income, receivables and payables. Many are left wondering how they went out of business while their clients and revenues were growing substantially.

In the event of persistent cash flow challenges, business owners need to immediately take proactive measures to shore up their cash posture such as identifying ways to decrease fixed costs, renegotiate payment terms with their major suppliers, and seek help from banking institutions.

Establishing a successful consulting business is not a spectator sport, and inaction is the surest way to a complete failure. Carol Phelps, CMC, MBA is the CEO of Global Financial Analytics, a management consulting company that designs and implements economic and business development programs with an emphasis on emerging markets. In addition to financial analysis, forecasting and planning, Carol’s expertise includes project management, financial literacy training and business plan development. Carol earned an MBA from Indiana University, where she was a Consortium for Graduate Study in Management Fellow. Carol received her CMC in 2011.