Designating available cash with precision and intention is critical to the health of a business. Whether a company is enduring a cash shortfall or enjoying a season of plenty, the use of available cash can either advance the company or hinder its success.

We must be intentional with the funds available in a company. While a lack of funds demands that we become intentional with cash on hand, managing the discretionary funds (funds not designated for a specific purpose) is equally critical to protect the company’s cash flow needs. Once we realize that available cash has a designated purpose, we will no longer view it as discretionary funds to be spent on a whim.

In this article, I suggest a sequence for prioritizing cash that can help a company accomplish two objectives: 1) Maintain company operations while building a cash reserve. 2) Target the elimination of debt obligations.

The following sequence should be used to prioritize available cash:

1. Pay current bills/accounts payable/payroll down to zero
2. Pay the line of credit down to zero
3. Build a modest cash reserve (3-6 months overhead)
4. Pay off loan amounts entirely to eliminate monthly payments

Each number in the sequence is explained in more detail below.

1. Current obligations must be met for the company to continue functioning. These are a priority before other obligations and include all operational expenses such as payroll, payments to vendors, debt payments, utilities, and insurance. Cash must first be directed towards current obligations if the company is to remain open and functional.
2. The line of credit is the available cash source for needs in the company. Paying it down to zero allows the maximum cash to be available if a need arises in the future. Repayment of the line of credit should take priority over making additional long-term debt payments.
3. A modest cash reserve allows a company to function without going back into the line of credit and protects against any negative cash flow cycles. Saving enough cash for 3-6 months of overhead expenses gives sufficient cushion for a company to adjust its business model if a prolonged downturn in business occurs.
4. While eliminating debt is certainly the goal, paying off a portion of debt without retiring it completely, will tie up operating cash without removing the payment obligation. From a cash flow perspective, the goal of paying off a loan is to remove the monthly payment and free up that cash for other purposes.

By managing and prioritizing the cash flow in a healthy business, a business owner can provide the cash needed for operations and pave the way for a successful, less stressful future in the company.