The idiom Cash is King has always stood the test of time. You can be a profitable business (by showing positive net income) and still be cash poor. We get asked a lot by our customers why that is the case. Let’s define what cash flow is in the first place. Very simply, cash flow is the sum of all the cash inflows you receive from products, services, and/or assets in your business minus the cash outflows you pay from products, services, and/or liabilities in your business.
To illustrate this, let’s do a very simple example of what this could look like in a business:
Jasmine has $0 in her bank account but receives $100 of cash for completing a service (that’s revenue on your profit & loss statement). Jasmine turns around and invests the $100 into some equipment that has a useful life of 5 years and needs to be recognized as a capital asset (on your balance sheet). Jasmine is now back to $0 in her bank account (insert sad emoji).
Because Jasmine bought a capital asset, she can’t expense this immediately. It needs to be depreciated over the useful life of the asset, so she only gets to recognize an expense of 1/5th (because it has a useful life of 5 years) in the first year (we’ll ignore the half-year rule in this simple example, and if you don’t know what that is come talk to us).
Her P&L would now show $100 of revenue and $20 of expense. Yay! She made a profit of $80 ($100 – $20). But she has no money in her bank. What gives?
This very simple example outlines one reason why Cash. Is. King. Always! Cash came in for a service but immediately went out the door to cover the purchase of equipment. Business owners should focus on understanding their cash flow above all else in order to make the best decisions for the future of their business. Otherwise, you’ll assume your business is doing amazingly with an $80 net income but no cash as a result.
So, how do we solve this problem? By focusing on cash flows! Cash flow management should be at the forefront of every decision you make in your business.
Through our experience working with numerous entrepreneurs, we’ve created Our Blueprint to Fixing Your Cash Flow Problems. Here are our top 5 tips.
Cash Flow Tip #1: Stop getting paid on completion
Here’s another idiom for you: A bird in the hand is worth two in the bush. This idiom tells us that having something now, even if it’s in a lesser quantity, is worth more than waiting for a more desirable alternative. The key word here is waiting. Why are you waiting to receive a payment upon completion? Get paid up-front or in installments to reduce your own cash flow burdens.
How do we fix this? Make it mandatory in your contracts for an up-front payment or installments. From our experience, no one has ever disagreed with this. Use a software to collect money up-front, such as a credit card processor, your bank, or a pre-authorized debit would work perfectly. And before you say, “I would never collect money using a credit card, the fees are outrageous”, while I agree with you about the fees, remember the idiom above. You can get paid immediately with a small convenience fee or chase your customer for payment (PS: chasing customers is a waste of time and money since you won’t have the cash in hand).
Cash Flow Tip #2: Please stop spending the governments money
Yes, you did charge some $100 + HST (I’m in Canada so we’re sticking with HST). But guess what? The HST is NOT your money, it’s the governments. You’re holding it in trust to remit back to the government. The nice thing about this whole situation is that you can reduce your HST owing from sales by making purchases that have tax on them.
Another simple example: Sell something for $100+13% HST and you owe the government $13. Buy something for $50+13% HST in the same period and you now only owe the government $6.50 ($13 – $6.50).
How do we fix this so you don’t spend the governments money? Open a new savings account and name it HST Owing. Each month-end move an amount from your operating account into the HST Owing account and DO NOT TOUCH THAT MONEY! It’s not yours to begin with. If you don’t do this, you will most likely have a cash flow problem come HST filing time. I’ve seen it countless times and this is a simple fix to make sure you’re not spending what isn’t yours. Chat with your bookkeeper or accountant on how much to move to your HST Owing account. Better yet, chat with us (insert winking emoji).
Cash Flow Tip #3: Renegotiate terms on payables
If you’re struggling to make payments for goods, services, supplies and other items (payables) that are vital to running your business, speak to your suppliers and renegotiate your current payment arrangement. Can you pay later? Or pay in smaller increments? Heck, I just recommended in tip #1 above to do installments on your own services or products so why wouldn’t one of your suppliers agree to this, too?
Conversely, be sure you’re not paying for something that you aren’t actually receiving. If part of your inventory, for example, is currently unattainable due to supply chain disruptions, then this is a product you cannot sell. Paying for something you haven’t received and cannot sell impacts your cash flow on both ends. Can these payments be canceled or paused?
Do you know what your cash conversion cycle is? No? You should pay close attention to this. It’s a metric that tells you how quickly you turn investments in inventory and other assets into cash INFLOWS from sales. FYI: you want this to be negative at best but less than your average days to pay suppliers at worst. This metric is a good indicator of excellent cash flow management. Here’s how it works:
Average days to collect from customers – average days to pay suppliers + average days to turnover inventory to revenue
For a service-based business, just drop the inventory part of the formula. As long as your average days to collect from customers is less than your average days to pay suppliers than you’re sitting pretty.
Cash Flow Tip #4: Review expenses on a regular basis
Have you ever looked at your credit card statement and thought “wow, I didn’t know I was still paying for that?” Don’t worry, I have to. It happens. But, continuing to pay for unnecessary expenses is a burden to your cash flow. By reviewing your expenses on a regular basis you’ll be able to see what you could potentially cut to reduce your cash outflows.
You should at least review your expenses on a quarterly basis. If you can do it monthly with your accountant or bookkeeper, then I would recommend that. I personally find it extremely annoying when I pay for something I’m not using. I’m sure you would agree. So, make sure that you’re reviewing your expenses on a regular basis to reduce your cash outflows.
Cash Flow Tip #5: Say it with me, Cash Flow Projections
This is the tip that pulls everything together. You can make all of these adjustments, but if you’re not actively working on cash flow forecasts and comparing your actual data to these forecasts, then you can’t learn from what you’ve been doing and implement changes. It’s crucial to look back and forward at the same time with regards to cash flow.
For most businesses, payroll is the largest expense, representing upwards of 75-80% of total expenses. This is so easy to project in a cash flow forecast. It’s a fixed cost. From there, all you’re really looking at are your variable costs related to sales and other operating expenses.
There are some very easy ways to create your cash flow forecast. You can use Excel if that’s your jam. I would recommend using a cash flow forecasting app such as Float, Futrli, Helm, or Jirav. Each of these apps have their own respective strengths, but any one of these would fulfill your needs to help automate your cash flow forecasting, compared to manually updating an Excel workbook.
If there’s one thing you take away from this guide, please make it this final tip.
That’s it! Five tips to help you improve your cash flow.