There are so many books, blogs, and videos out there trying to tell you the miracle cure for success. There is a plethora of #’d lists to solve all of your problems.
10 Steps to Business Success
19 Little Things You Can Do To Turn Your Business Around
The 432 Facts About Small Business Finance
…..and so on
To be fair, a lot of these have some good tips, most of them based on common sense. I read them all the time, and I’m sure I’ll write a few of my own someday. If you already have a strong foundation, these can be very helpful to get you to the next level. But in the beginning, before you’ve reached a level of success, you have to go back to basics. In the past 20 years, I’ve noticed one common trait to all successful businesses, big or small. It’s also the one common factor missing in most of the businesses that don’t make it. It doesn’t involve social media, R&D, or hiring the right people. It’s much simpler than any of these things but can be so much more difficult to get right. So, what is it?
Positive Cash Flow
Cash flow (also "cashflow") refers to the movement of cash into or out of a business, a project, or a financial product. It is usually measured during a specified, finite period of time. (Here’s how Wikipedia describes it)
It’s a simple concept. You want to have more money coming in than going out. I’m pretty sure a basic understanding of this concept occurs the first time you get an allowance as a child. It’s one of those obvious facts of life that get neglected on a regular basis. Others include;
I should start saving for my retirement in my 20’s.
I should eat better, and exercise more.
I should stop using my credit card for take-out, and then only make the minimum payment each month.
Unfortunately, just because it’s obvious doesn’t mean it’s automatic. In business, it’s really easy to get caught up in the wrong financial statements. When a bank or vendor asks for financial statements at the end of a fiscal year (at least where I live), they usually focus on the same two statements; the Income Statement and the Balance Sheet.
The Income Statement shows your income, your cost of goods sold, and your other expenses. A good result on this statement means you sold your products or services for more money than it cost you to buy them and support the business. The balance sheet shows your Assets, your Liabilities, and your Equity. Basically, how much you have or will have, whether tangible or not, and how much you owe or will owe. The difference is your equity, positive or negative.
These are very important to judge the success or failure of a business. However, focussing on these exclusively can be disastrous.
How can my Balance Sheet and Income Statement look great, but I’m still broke, and my business is falling apart?
Let’s think about what these two things are telling us.
Income Statement:
Let’s say you generate $1,000,000 in revenue this year. The products you sold cost you $500,000, and the rest of your expenses (wages, utilities, advertising, etc.) cost you $400,000. You had a 50% gross margin, and $100,000 in net profit. That’s great, and hard to find in the last couple years. Shouldn’t there be $100,000 in my bank account now? Well, no, not usually. What if 1/4 of your customers haven’t paid their account yet. You could have $250,000 in receivables (money people owe you). Maybe the increase in sales made it necessary to buy a bigger building. These 2 expenses don’t show up on a Profit/Loss, they’re over in the Balance Sheet.
Balance Sheet:
Let’s say your balance sheet looks great too. You have $1,000,000 in assets, and you only owe $800,000. That’s great! My business is doing so much better than everyone else, right? Well, once again, not necessarily. Again, assets aren’t just cash. They’re made up of cash, receivables, and other items of worth (usually buildings, land, inventory, and vehicles). Receivables are only assets until you realize that the customers aren’t going to pay you. If the economy were to take a turn for the worse, and suddenly 1/2 of the customers who owed you money went bankrupt (sound familiar), then what?
As you see, it’s not hard to look great on paper but still not have enough money to put gas in the company car. If all of your money is tied up in inventory sitting on a shelf, how do you pay for the furnace when it breaks down?
This is a topic that I could write about for days, and I think I’ll put together something more substantial, perhaps a guide or eBook. The main point is this; you need to have fast, positive cash flow in your business at all times. Just like in your personal finances, you need to have the cash available to you when disaster or opportunity strikes. Here are some examples:
Small Business Disasters
your store needs some major repairs (i.e.. furnace, plumbing, new windows)
you ordered an expensive item for a customer, they bail, and the vendor won’t take it back
your tax return gets reassessed, and you suddenly owe $10,000 more than you thought
Smal Business Opportunities
one of your vendors is offering you 35% off your order if you pay for 3 months’ worth of product in advance
a booth just opened up at the trade show you want to attend, but it’s next week, and you need to fly 2 of your employees down
a smaller competitor is struggling and has decided to sell the business, giving you the opportunity to buy it and open a 2nd location
Ok, fine, I believe you, now what do I do?
Every industry is different, but here are a few tips that apply to a lot of businesses.
Extend credit to your customers very carefully:
Some of you eBay sellers and convenience store owners don’t run into this. However, there are still a lot of small businesses that give credit to their customers on some level. This is especially true when your customers tend to be other businesses. Be very careful to who you offer terms. Think of it as giving them cash out of your pocket or giving them the keys to your car. Would you do that with a stranger?
If you are in an industry where this is a necessity, at least follow this advice.
Keep the terms for repayment short. Instead of giving them 30, 60, or 90 days to pay you back, offer them 7 or 14 instead. Consider offering discounts for early or pre-payment.
If it’s business, get some referrals from their other vendors, and have them fill out a vendor application.
If it’s an individual, run a credit check, and have them sign a credit agreement.
It’s a bit more paperwork, but it will save you a lot of trouble in the future.
Inventory Management:
Having $1,000,000 of inventory on the shelves looks great on a Balance Sheet until the products get old or the fad dies off, and now they’re only worth $500,000. Sure, it’s good to buy in bulk to get the discount, but there’s a fine line you need to walk. If you’ve been in business for a few years, sit down this weekend and look over your sales figures for the past few years. If there are items that sell well, year after year?
Talk to your vendor, and negotiate a really big discount on buying 3, 6, or even 12 months’ worth of that stock.
Try to get them to give you good repayment terms so you’re paying more during the busy season and less when business is dead.
Never buy fads in large volume unless you can afford to lose big. For every Tickle-Me Elmo, there are a hundred Segways rotting away in warehouses.
Run your business the same way you run your house. If you have $1000 in the bank, would you go out and spend it all on toilet paper, even if you know you’ll use it eventually? Of course not. You’d be broke, and having thousands of rolls of toilet paper on hand wouldn’t do much to appease your impending hunger.
Buy vs. Lease or Rent:
There are a lot of opinions on this debate. I also know that there are lots of tax implications that come into play, which is a topic that could take up a bookshelf, so let’s avoid that for now. Let’s discuss this as it pertains to cash flow.
Before you make a large asset purchase, like a building or a vehicle, consider your current cash position. If you have to go into significant debt or spend all of your emergency cash, I would think twice. In the first few years, especially in a micro or small business, financial agility is very important. I understand the value of owning the building. The long-term benefits of an asset that goes up in value as the amount you owe goes down are obvious. However, unless your trust fund is paying for this, you’ll want as much money in reserve as possible. Renting and leasing the equipment, vehicles, and building gives you a consistent monthly payment and frees up your cash and credit for inventory, emergencies, and opportunities. Here are a few quick points:
Renting an office can save you from repairs and maintenance on a building you own
Sign shorter leases (if any) if you think you’ll outgrow the office quickly
Upgrading rental equipment and tools is much easier than selling and buying
Summary:
Look, if your business has a war chest like Apple or Microsoft, you can approach this much differently. The point of this is to get you from where you are to where they are. Companies like Apple are powerful because they have that kind of cash to spend if they need to. They can weather a big lawsuit, buy a rival company, or test out crazy product ideas without worrying too much. However, we’ve seen plenty of times when a big company had fallen because they were too focused on profit margins but didn’t have any money in the bank when they needed it.
You want every dollar you have to be working as hard for you as possible. Instead of buying extra inventory to store in the back, why not invest some of it, or pay off the company credit card? As a small business owner, you have to spend every dollar as if it were your own because, most of the time, it is.
If you’d like to read more, check out this post about small business cash flow.