As published in “Southwest Florida Business Today”, January 2021
For many years, companies paid little attention to cash flow. The focus was on sales and profit. It was assumed that there was enough cash in the bank, or in the cash drawer, to pay the bills. “After all,” it was thought, “we’re profitable, so there must be plenty of money.”
Businesses (and investors) began to realize that profit margin alone was not enough to insure real financial success. Understanding where those profit dollars go, and how much is really left over (and when) is very important. You don’t need to be an accountant to understand this, but you should learn the basics of cash flow and how it effects your business.
Whether it’s a lemonade stand, or an automobile factory, to sell a product, you first spend money to buy supplies. Then you pay your workers to make the product. Finally, you sell the product and get paid by your customer. The cash you receive from those sales can buy more supplies and pay workers to keep the business operating. But, timing is everything …and is all the cash in hand always yours?
Using the lemonade stand as a simple example, suppose you borrow $20 from Dad and buy a card table, chair, and a pitcher at a yard sale for $13. You go to the store and pay $7 for lemons, sugar, bottled water, ice, and cups. You make $15 selling all your lemonade that day. You have $15 in hand! Woo hoo! Wait a minute – you spent $20, which you owe Dad, and you only have $15. That’s negative cash flow of $5 for Day 1. OK, the next day you pay Dad $8, use $7 to buy more ingredients, make more lemonade, sell it, and earn another $15. You spent $15 and received $15 – zero cash flow for Day 2. Ugh. Well, that’s an improvement anyway. On Day 3 you pay Dad $8 again, and pay $7 for more ingredients, and sell the lemonade. Again, you have $15, but you spent $15 – zero cash flow again! On Day 4, you give Dad $4 to complete your loan repayment (fortunately, he doesn’t charge interest), buy the ingredients for $7 and sell out the lemonade. Now you have $15 again, but you only spent $11, so for the first time you have positive cash flow – wow! $4. That’s your money! Despite the fact that you were technically “profitable” every day, your cash flow wasn’t positive until Day 4. Hopefully you get the idea – paying attention to cash flow is important.
This lag between the time you spend the cash and when you get it back is a big deal. If you give customers credit so they can pay you later, this time increases. Think of managing cash flow as getting the money you earned sooner, which gives you better financial flexibility to buy supplies and invest in your business. Who doesn’t want their money sooner?
What kinds of simple actions can you take to increase your cash flow?
- Collect your money from your customers as soon as you can and put it to work for your business. I’m always surprised by how many businesses don’t cash checks for days, or even weeks after receiving them. That’s crazy! Put it to work right away paying debts, buying supplies, earning interest, or investing, or just saving for a rainy day (literally, for the lemonade stand).
- Manage your supplies. If you buy a month’s worth of lemons, you might get a slightly better price, but all that money is gone, some of the lemons might go bad, and you may not have enough cash left to buy the rest of the ingredients. Maybe a few days or a week’s worth of lemons would be better?
- Manage your “finished goods” inventory. Don’t make more than you can quickly sell. It’s great to be able to respond quickly to customer demand, but don’t have too much of your money tied up in completed products waiting to be sold.
- Work with your suppliers to develop a plan to pay them as long after their delivery as possible. What if you bought your lemonade ingredients with a credit card? For most of the month, you would actually get paid by your customers BEFORE you have to pay for the ingredients. But, make sure you save enough of those profits to pay the credit card bill at the end of the month – in full!
- If you can, raise your prices to increase your profit margin. This can be dangerous if you are in a highly competitive market. You might actually lose sales, so be careful.
Monitoring and controlling your cash flow should be a high priority. It can be an indicator of your business’ financial health, and a critical tool for improving the way you can spend, invest, or save money. Cash is, indeed, king!
Copyright 2021 Seabreeze Associates, LLC
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