Let’s say that you’ve created a business plan and you’re pleased with the outcome. You plan on selling 2,000 units of your product at $100 each, netting you more than $200,000 in operating income for the year ahead. Sounds great. You factor in your costs of just $80,000, and you have a gross income, before taxes of a healthy $120,000. All good so far.
You go into the year, working towards your financial goal, never worrying about whether you have the cash on hand that you need to buy things like labor, advertising, and goods from suppliers. After all, you’re making a profit, right?
Not so fast.
All that money you’re making is great news, but if it’s coming in lumps and bumps, then your immediate outgoings might be more than the cash you have on hand, triggering a cash flow crisis.
Most people who haven’t been in business before think that the main obstacle that firms face is remaining profitable. But the real challenge is solvency: having enough cash on hand to meet all of your obligations. Even profitable firms can go out of business if they don’t have money to pay the bills.
Think about it this way: there’s often a delay between you providing your service and money from clients going into your bank account. Family law firms, for instance, usually charge customers at the end of the month, sometimes weeks after services have been rendered. During that time, the practice still has to pay rent and electricity bills, not to mention wages to support staff, which all costs money. Without money in the bank, it can’t do that, creating enormous problems.
Cashflow is key to keeping your business healthy. But how do you make sure you balance your incoming cash with your outgoing? Take a look at some of this hard-won advice.
Recognize That Profit And Cashflow Are Different
Profit and cash flow are two different things. Profit is how much money your firm made in total, minus expenses, over a given year. Cashflow is the money you have on hand at any given time to meet your obligations. As we’ve discussed, your company could be highly profitable, but if you’ve got no money in your company bank account right now, you can’t do anything.
Planning your cash flow ahead of time is essential. You need to be able to work out when your cash flow situation will be good, and when it will be bad so that you can plan ahead of time and take out credit, if necessary. Some firms, for instance, will buy your accounts receivable, paying you a percentage of the money you’re owed by clients, giving you cash there and then, instead of having to wait days or weeks for payment.
Build Your Cash Reserves
If you ever look at the balance sheet of a major company, you’ll notice something: they keep a lot of cash in the bank.
The reason they do this isn’t always entirely apparent. Why not just return the excess money to shareholders or invest it in new equipment or product development? It turns out that merely holding cash has value. Companies want cash on hand so that they can buy stuff that they need, just in case a client doesn’t pay on time. Having lots of money gives you options and helps you to ride out the storm. Firms that have enough cash can continue to meet their obligations, even if no new money is coming in.
When you think about it, having this level of security is vital. Imagine for a moment if you couldn’t pay your staff for a month. Not only would it be extremely inconvenient for them, but many probably wouldn’t bother turning up for work and would instead look for jobs elsewhere. Worse still, the quality of their work might go down, wrecking your reputation. You could also run into issues with suppliers, or lose your favorable rates for being a long-term reliable customer. The costs of poor cash flow management can be extreme.
Secure Lines Of Credit
Okay, so what if you don’t have a cash mountain? What are your options then?
Many startups and small firms don’t have a mountain of cash to see them through the rough times. That’s perfectly understandable: when you’re just starting a business, you face all kinds of expenses which eat into your capital. It takes time to scale sufficiently to achieve profitability.
If you can’t generate the cash you need to sustain your operations, you need to get it from somewhere. Creditors are people who supply businesses with temporary capital to cover their outgoings so that they can continue to work towards profitability. In other words, when you get low on cash, creditors step in to make up the deficit. Sure, you have to pay them back with interest, but they take the pressure off when you need it most.
There are many different types of credit you can get, but one of the most innovative is the merchant cash advance. This type of credit is where a third-party company provides you with an unsecured loan to cover your immediate cash-flow needs. Firms that offer card processing services often provide it. If you don’t take much money in a particular month but expect to make more next, then they can be a great option.
Choose Somebody To Monitor Cash Flow
Your cash situation can change dramatically from day to day and week to week as you try to balance your expenditures with your income. Cash can fall sharply when you take on a new member of staff or undertake a new project.
It pays, therefore, to assign a member of your team to keep tabs on your bank balance. Ideally, they will plan and manage cash flow according to company revenue expectations and warn you ahead of time if there will be a shortfall.
Many company bosses also get their cash flow monitor to tell them when the amount of cash they have on hand falls below a certain threshold – say $10,000. It’s an early warning sign that something needs to change.
Collect Your Receivables As Fast As Possible
Receivables is an accounting term describing payments you’re owed for work you’ve already done. So, for instance, if you’ve installed a bathroom for $10,000, but the client hasn’t paid you yet, you have $10,000 in your accounts receivables.
As you might imagine, receivables create problems for cash flow. If you’ve spent money on bathroom fixtures, fittings, and labor, then you’re probably significantly down on cash. You’re relying on the customer sending you money so that you can remain solvent.
Companies with healthy cashflow ensure that they get paid as quickly as possible for work done, and ahead of time, whenever possible. In some industries, paying first isn’t acceptable, but that doesn’t mean that you shouldn’t look for ways to speed up the process. Instead of giving customers the usual 30 or 60 days which might be standard in your industry, you could try reducing the payment time horizon to just ten days or less, depending on what clients will accept. Shortening the payment horizon reduces your risk by ensuring that money makes it into your account faster.
Create A Cashflow Worksheet
Cashflow worksheets help to take the guesswork out of managing your cash flow. Instead of just relying on instinct or manually planning, worksheets show you month by month, and sometimes day by day, when you’re likely to run into cash issues, based on your current income and spend.
Know What Your Breakeven Point Is
The concept of breakeven is vital in business: it’s where you’re selling enough products or services to cover your costs. But breakeven is also critical for companies wanting to know whether their cash flow situation will deteriorate over the long term.
Let’s say that you’ve got a cash pile of $5,000 and you’re selling $500 worth of goods every month. Your costs, however, are currently running at $600, meaning that you’re losing $100 per month. Even if you’re paid immediately, you are eventually going to run into a situation where you run out of money. Losing $100 for 50 months on the trot will cut your cash pile to $0, and when that happens, you’ll have nothing left to dip into to pay your ongoing costs. Not good.
Remaining profitable, therefore, is a necessary condition for good cash flow long-term, but it’s not sufficient. You still need enough cash-on-hand to meet your obligations.
Extend Your Payables
Extending your payables is a way of flipping the situation on its head. Payables are money you owe for services you have consumed. If you suspect cash flow problems, then you may want to negotiate different payment terms with suppliers. Rather than paying them within 30 days, you might ask if you can pay them in 60 instead, taking the pressure off.
Cash flow isn’t always the most straightforward concept to get your head around. But once you understand it, it can help your company enormously.