Running a business without managing cash flow is like trying to live a healthy lifestyle on donuts and milkshakes. If you manage to stay out of the hospital, it won’t be with six-pack abs, well-defined calves, or an abundance of energy.
Our goal at EntrepreneursRx is to provide you with strategies, ideas, and approaches that will holistically support your business at its various stages of growth and health. We want you to advance from Chaos to Growing, Healthy and Thriving! This is best done by focusing on the seven pillars of business success: Finance, Team, Marketing, Sales, Product, Systems, and You.
With that in mind, let’s talk Finance, and specifically about cash flow management both from an information and implementation standpoint.
There are three critical parts of your cash flow analysis: accounts receivable (payments owed to you for goods or services), accounts payable (payments you owe others for supplies or services) and shortfalls (where payments coming in aren’t sufficient to cover the fees going out). Can I hear a resounding “Ugh!”?
You must manage all three simultaneously and effectively. Let’s discuss how.
It is crucial to know when your business will become profitable — specific, pinpoint accuracy here. Not, “It will be profitable when I make more than I spend…”. Specificity will provide clarity and focus for you early on and helps guide you towards your goal.
The formula to figure your breakeven point is to divide the total fixed costs of production by the selling price LESS the variable costs to produce the product.
For example, Fred sells photo art. Fred immediately thinks of his expenses to include canvas, ink, and shipping. (Additional research will be required of him to establish the potential various shipping expenses.) A $100 wall canvas, shipped to Corrales, NM for $50 is actually … not a $150 expense.
So, before Fred decides to sell his art for $200 (and thus thinking he is making a $50 profit), he needs to figure in the often-overlooked variable costs. Operating costs of printing equipment, office space, electricity, packing peanuts and tape (to name just a few) all add up, and those little expenses will cut into Fred’s margins and keep him from hitting his breakeven point sooner.
New businesses often take two to three years to reach profitability, but that number is often misleading if the company is paying salaries, expenses, and other items that the entrepreneur would have previously paid for out of pocket.
If Fred, the artist, was making 50K a year as an art teacher but took 50K in salary from his canvas art business, and the company showed zero profit after paying expenses, Fred would say the company had a successful first year. He knows from his exposure to EntrepreneursRx that as he grows the business and learns more strategies, he can improve the margins between expense and profit to be more extensive, and thus more profitable.
What is your break even point?
Another critical aspect of cash flow is to keep your eye on the management of your cash, not on profits. Hey, wait a minute! Didn’t I just say number one was to know your breakeven point (i.e., profit-margin)? Isn’t focusing on cash flow and not profits a contradiction to what I just said? No.
Use your breakeven point as a benchmark. After you reach breakeven and your business is profitable, you still need to manage cash flow.
One of the best ways to manage cash flow is to set aside some money at the very beginning; a “do not touch fund” if you will; not to be figured in when deciding how much money it will take to start your business.
Never fear if you have already established a business and you didn’t do this initially. Start it now. Almost all businesses experience shortfalls and you are especially vulnerable in the beginning when you don’t know what you don’t know. EntrepreneursRx will provide you with wisdom to help you minimize those shortfalls, but like learning to walk, falls are a natural part of the learning curve. How you anticipate, manage, and recover from those shortfalls may determine your business’s viability.
If you have your “do not touch fund” as a reserve, it will be easier for you to focus on cash flow and not feel shortfalls as profoundly.
Use a cash flow spreadsheet in the cloud for quick reference and ease in accessibility. Many banks offer access to accounting software (for free or for a reduced fee) and make sure your files are secure. Click here for a cash-flow worksheet template to assist you in establishing your working capital requirements.
One of the best ways to manage cash flow is to collect receivables as rapidly as possible (keep your net-30 and net-60’s to a minimum). A key aspect of collecting receivables quickly is to put someone in charge of managing them.
This trustworthy person will need to monitor outgoing bills and contact customers to receive payment. Often invoices are overlooked, and a phone call or follow-up is all that is required to remedy the problem. Make sure the person in charge of this is reliable and tenacious (all the time with a constant smile).
Even better than having someone keeping an eagle eye on receivables, is establishing a system where customers are encouraged to pay sooner. The heating and cooling company I use offers discounts if I buy their bi-annual service one, two or three years at a time. I am happy to pay early as I receive the service at a saving. The company is satisfied as they receive their money sooner and avoid the potential expense (and headache) of collections.
Also, keep credit standards strict. Establish a clear, written set of requirements for determining who is eligible for credit. Adhere to those standards unwaveringly. You don’t want every customer approved for credit, no matter how nice they are or how much you need the sale.
On a similar note, you will want to expand the amount of time for you to pay your payables. Many suppliers will do a net-60 or even net-90. Take advantage of those. At the same time, watch out for late fees as they can quickly eat up potential profits. If you put someone in charge of monitoring the receivables, they would also a viable candidate for the responsibilities of payables. This person (which might be you) needs to control cash flow with precision. Certain thresholds (which will vary from business to business) must be identified early to avoid crises (i.e., the company checking account can’t drop below a certain level). You will need to have a clear line in the sand as to when you draw from the “do not touch fund” and make sure that all other options have been exhausted. As soon as possible, replace the fund to its original (or even better- higher) value.
When your cash flow remains positive, your body of business can take on its fitness regime and feel the effects of healthy choices. Solid, realistic planning, based on reliable and sound financial information, takes out the speculation and helps ensure success. So take your business’s pulse. How many of the suggested guidelines were you able to check off?