According to a U.S. Bank study, 82% of businesses that fail do so because of cash flow problems.  There seem to be three camps when it comes to understanding the concept of “Cash Flow”.   Most people (including business owners) believe they intuitively understand it.  Some have a vague knowledge of it but don’t want to appear “dumb” and ask somebody what it really means.  The third camp actually understands it, plans all of their operations around it, and prioritizes it over almost everything else in their business.  Can you guess which group tends to succeed in business?

Cash flow’s definition is deceptively simple: the movement of money in and out of a business.  While “easy” to define, it’s one of the most complex challenges any business, lender, investor, or advisor can face.

If you happen to be in the camp that somewhat understands it, but doesn’t want to ask for help for fear of judement, fear not.  You’re in the vast majority.  To give you an example, imagine for a moment the average business banker reviewing a loan request:

When bankers ask for financials, typically some of the most critical pieces of information are the Income Statement (Profit and Loss) and Balance Sheet.  When they review the numbers with you, they might ask what caused profit to go up and down, what your receivables are, why sales went up or down, etc.

What the average bankers don’t ask you, and probably don’t even know, is why your inventory turn went from 30 days to 60 days.  They probably won’t tell you that your average receivables collection cycle lengthened from 30 to 45 days.  This meant that you tied up cash worth 15 days of sales, which led to you now needing a line of credit to fill that gap.  Most believe that they need a few years of historical information to see what the “trends” in the business have been.  The real reason for needing multiple years is not only to review trends but also, and more importantly, to be able to build and assess the most critical statement for any business: the statement of cash flows.

A few of you reading this might be accountants, for the rest of you, here’s how you can improve cash flow without spending a couple of years taking finance and accounting classes:

1.  Build a budget and review it against actual numbers at least monthly.

Budgets can range from as simple as bullet points on a napkin of what you want to sell on a regular basis, how much you’ll make, and what you think it will cost you to mutli-tabbed, interactive spreadsheets that model out hundreds of scenarios and line items.  It doesn’t have to be complex to be useful.  It doesn’t have to start with January 1.  The simple process of saying “how much will I sell, how much will it cost me, and is what I currently have enough to fund that?” on a monthly basis is light-years ahead of most businesses.  Do your best, don’t worry about it being totally correct, and review it against what actually happened.  You will find that you “intuitively” know a lot more about your business than most other entrepreneurs.

2.  Be religious about minimizing receivables.

I’ve told clients this very phrase at least 1,000 times:  “Anybody can sell anything if the customer doesn’t have to pay for it”.  Entrepreneurs are generally either very technically knowledgeable, incredible sellers, or in rare cases, both.  Those that are incredibly gifted in sales, or as my dad puts it “Could sell ice to an Eskimo in winter”, often believe that sales are all that matter.  I’d argue that collecting is all that matters.

Of course, you have to sell to collect, but if you’re out in the market selling on 30-60-90 (or never) terms, you have to be extremely careful.  Every sale requires some amount of money to be spent to deliver what you’ve sold.  That can add up in a hurry if you’re not collecting fast enough.  That’s not to say you shouldn’t or won’t often be required to sell on terms (net 30, for example).  Keep in mind, though, that when you do it, you’re making a loan to somebody.  They’ve promised to pay you.  Be careful about who you lend to and don’t be shy about asking for your money.  Make it easy for them to pay you- accept credit cards, direct deposit, electronic checks.  Offer discounts, if you really understand your margins.  Get a remote deposit machine and electronically make deposits every day (remember it’s not actually cash unless it’s in your account).  Collect, collect, collect.

3.  Be religious about minimizing inventory.

Michael Dell is perhaps most well known for completely changing the computer industry by ensuring that his company, Dell, keeps virtually ZERO inventory on hand without a purchase order to back it.  He might as well have been a sorcerer at the time he introduced the concept.  While it was novel in the computer industry, it wasm’t a new concept.

Another story that bankers are fond of telling is the tale of “Popcorn on the Cob”.  One day a banker makes a loan based on a great business plan (we won’t debate the merits of “great” here) to a man who is founding a company.  The owner wants to sell whole corn cobs treated a certain way so that you just put it in the microwave for a couple of minutes and out comes a great bowl of popcorn.  A year goes by after the loan is made, the banker goes by to see the warehouse, and the owner couldn’t be more proud, “Look at all these boxes filled with my product”.  The banker almost has a heart attack.  Why?  Because all his money went to inventory.  The company had some sales, but not nearly enough to move this inventory.  Some of the boxes were a year old and this product only had a 90-day shelf-life.  The company went bankrupt.

If you sell a product, it’s almost always better to sell out than keep a lot of inventory sitting around.  If you can’t sell it, nobody else can either.  Don’t tie up your capital in inventory just because it feels good.  Project what you need, be conservative, and order more with rush shipping if you have the fortune of selling more than anticipated.

4.  Take advantage of discounts

Businesses like to be paid quickly (see #2).  As such, many offer discounts for paying early.  If you’re in a relatively stable business, this is a perfect time to put more money in your pocket by utilizing either excess cash and/or a low-cost line of credit to take advantage of discounts.  If you borrow the money, just be sure to pay it back when your customer pays you.

Here’s an overly simple example of how using a line of credit to take advantage of discounts can help a business:

  • Business purchases $100,000 of material and has an opportunity to receive a 2% discount if they pay within 10 days.  (a very normal scenario, by the way)
  • Business borrows $100,000 from its Line of Credit, which has an interest rate of 5%.
  • Business pays down the line of credit $100,000 in 30 days.
  • The cost of the interest is about $411.00
  • The savings from the discount was $2,000.00
  • The owners just gave themselves a bonus of $1,589 dollars by using their money wisely.

5.  Know your “seasons”.

Many businesses have natural selling cycles.  A classic example is a small landscaping company.  In most of the U.S., spring and summer are when grass, flowers, and trees grow.  In fall and winter, flowers die, leaves fall, and grass goes dormant.  This means that the average landscaper is extremely busy in spring and summer, does cleanup work in fall, and twiddles their thumbs most of the winter.

Seasonality doesn’t have to coincide with the four common seasons, however.  Retailers tend to sell the most at the start of school and Christmas.  Hotels are most consistently full during the summer.  The list goes on.

Knowing your consumers’ tastes and when they are most likely to buy is critical to managing your business well.  If you’re a landscaper, think about ways to smooth out your customers’ contracts so that you don’t have zero revenue in the fall and winter.  Think about ancillary lines of business like tree and bush pruning, laying straw, commercial flower bed maintenance, etc that you can sell during the normal “slow” season.  These concepts can be applied to all businesses; the key is knowing your customer and planning accordingly.



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