One of the most common reasons small businesses come to us for a business loan is because they are either in trouble with their cash flow or trouble is coming. Sadly, poor cash flow management is the number 1 reason small businesses fail. According to a recent study by US Bank, 82% of small businesses fail due to cash flow problems.
What Causes Cash Flow Problems
- Accounting is not up to date. So often when we request financials to underwrite a business loan, the small business owner doesn’t have up to date financials. Also many file an extension on their taxes because their Profit & Loss (P&L) and Balance Sheet (BS) are not up to date. We recommend you at least keep your accounting up to date through the most recent fiscal quarter. Schedule some time to review your income, expenses, debt, and assets.
- Not knowing your break even point. The easiest way to do this is use excel or write down your total expenses from your bank statement each month and keep a running average. This accounts for every expense on a monthly basis including draws to pay yourself (that don’t go through payroll) and debt payments. For seasonal businesses, your break even point will vary so calculate your break even points as it relates to your busy season and slow season.
- Understanding Financial Statements. Get familiar with what your financial statements are telling you. Are you profitable? Does your balance sheet balance? What is the debt to income ratio for your company? Is your equity heading in the right direction? What trends are showing in your Accounts Receivable Report? A good CPA should be able to help you understand how your business is doing financially.
- Lack of Working Capital. Specifically, there’s no golden answer to how much cash a small business should have. Ask yourself, if my business had 3 months of negative cash flow, would my company survive? To find your current working capital, subtract your current liabilities from you current assets. Everyone says it, cash is king. The more you have, the better you are at directing your company strategically. Enough cash available to cover 1-3 months worth of expenses would be considered sufficient working capital.
- Poor Planning for a Large Investment in Your Small Business. An expansion, a new piece of equipment, a new marketing program. We’ve worked with a lot of small businesses who come to us first before any large expenditures to get an idea of how much money they have access too. Unfortunately some small businesses, leverage their existing working capital first which puts their cash flow in a bind. Don’t wait until you’re in desperate need of money to apply for a loan because at that point, it may be too risky for you to qualify for a small business loan.
- Not cutting expenses that you should. We see many instances where a small business owner is cash flow negative for a series of months, but the superfluous expenses continue. Are you still expensing your meals? This adds up and it’s only 50% deductible as a business expense. Do you have subscriptions to services that may not contribute much to your business – Spotify, online newspapers? Is it difficult to make payroll? Does your marketing produce measurable results?
How to Make Your Business Cash Flow Positive
Whether you started your business in a garage or in a beautiful building with investor backed dollars, the concept of business is simple. Can you bring in more revenue than your expenses? However, every small business comes to an inflection point.
What do I need to do to get this business where I want it to be?
What do you the business owner want out of this?
- A simple life with no boss and an ability to use your skills and talent in exchange for money.
- Make lots of money
- Grow and scale up your business until it’s valuable enough to sell
- Make your small business the pride of your family, community, and legacy
- Or something different
To achieve what you want successfully, the difference between income and expenses needs to be positive. Here’s what we believe works:
- Evaluate your relevant purchases and ask will this help me grow and sustain my business? Keep it just that simple. With this purchase help grow? How will it do so? What proof is there? When you make a purchase, do you define it’s purpose as it relates to your business?
- Make good, smart choices. If you’re not a numbers or strategy person, find one. If marketing isn’t your thing find someone who is experienced with proven results. If a piece of equipment is not keeping up with demand, upgrade or buy another one. If an item isn’t selling, make it better or discontinue it. If an employee is unproductive, be bold enough to understand that your business relies on dependable people.
- Research and test before big expenditures. Test before you buy. For example, maybe you found another vendor that sells invetory at a lower cost. Start small with a few orders while continuing with your current vendor. Evaluate how the new vendor operates. Do they deliver on time? Is their communication good? Is the inventory good quality? If everything checks out, then make the jump. Several years ago, we made an error in judgment by switching data providers without testing the new one. We did this because several of our colleagues recommended it, but it turned out to be a really poor choice for our business because specific data points that were important to us were inaccurate. If we had tested it first, then we would have saved thousands of dollars.
- Make it easy for your customers to pay you. There are countless ways to pay someone nowadays but some of the better ones we see are providing a payment link directly on an invoice that is emailed. Your customer clicks the link, enters their payment data and you’re paid in 30 seconds. Also, invoice early and often especially if collecting payment after a job is completed. Like we wrote earlier about keeping up with your accounting. Keep up with your invoicing and collecting.
- Short Term Financing. Good, short term working capital loans or a business line of credit can be strategic if your business has gaps between buying supplies and collecting payment. These are great for buying inventory for retail businesses and also for contractors who have to buy supplies upfront and keep up to date with payroll while completing a job.
- Long Term Financing. Paying cash for a piece of equipment can severely disrupt your cash flow. Buying a piece of equipment is similar to hiring an employee. You wouldn’t pay an employee before they work for you. Let the piece of equipment make money for you before start paying for it.
We want ALL small businesses to thrive and really what it comes down to is how much you are willing to think strategically when you spend and find ways to turn those dollars spent into a profit. As a business owner, you may not have the time, patience, or understanding of finances. If that is the case align yourself with people that can help you. Try to talk with small business owners that have been successful.
Research your competitors to see how they market their businesses. Know your strength(s) and become an expert in those areas. Invest in good people. And have the courage to walk a way from an unproductive person, vendor, or situation that doesn’t contribute to the benefit of your business.