Cashflow is the bloodline of your business, there is a reason large corporations have a whole department dedicated to the management of cash flow and cash flow forecasting. Have you ever seen a business that’s doing well, then suddenly one day their doors are closed? It’s almost always poor cash management. A study by US Bank found that 82% of small businesses fail because of poor cash flow management. Even if you are making a profit and doing well from a P&L perspective, effective cash management is essential to ensure you are able to finance operational activity and investments in long term growth and stability.
To effectively manage your cash position and long term future, you need to be able to answer the following: where is my cash going, why is it going there, and is that the best use of my cashflow. Understanding where you are spending your money, how much, as in what % of your revenue is being spent there, is the first step. When you know that, you need to understand how that compares to other competitors. Am I spending too much on marketing, not enough, am I doing the right marketing?
The next step is to understand why. What is my ROI on this spend, is this a necessary cost? Categorizing your expenses can be helpful in this step.
· Is the spend mandatory or discretionary
· R&D, G&A, Sales & Marketing, Operations
If it is a necessary spend, make sure you understand why, not just because your CIO says it’s a necessary spend, but understanding why it is, and what other spend options there are.
The third step is to make sure this spend is the best use of this resource. Everything has an opportunity cost, so you should make sure you have a process in place that validates this is the best use of your cash. What other options are available, what is the opportunity cost, and what is the ROI on this spend. If it is for product, what is the margin, a worker, what is the output, there is always a measurement.
Cash flow is all the more important to analyze and forecast as you grow and experience high growth periods. There is a common misconception that when you have a cash flow problem, you just need to focus on sales and increasing revenue. This is not true due to several factors. First, there are the more obvious items that impact cash as you grow, such as additional spend, headcount, overhead, hidden costs, etc. which is why it is important to keep your margin intact. But there could be other impacts from adding new vendors and customers in the form of payment terms. You may find that your sales are growing, however your cash is shrinking faster than it is coming in.
If your vendors have tighter payment terms than you do for your clients or customers, that means you must pay for your cost of goods sold before you receive cash payment for what you sell. If you are growing fast, this could put you in a difficult position. If you have a line of credit, you may need to use that, which comes with costs. If you do not have a line of credit, you may have to find funding, or use credit against your accounts receivable. If not paid promptly, this could hurt your relationship with new vendors.
As the old saying goes, you need to spend money to make money. If you don’t have money to spend, or don’t know how much you have to spend, or what best to spend your resources on, being successful long term will be an uphill battle. Fortunately, with the right people and processes in place, you can ensure a successful future and the longevity of your business.