I was recently asked: What is the greatest mistake first-time business owners make right at the launch of their businesses?
There are enough mistakes to fill several books, but in my experience the business killer is focusing on profitability. This may seem counterintuitive, as being profitable should be the goal of any business. But this goal usually comes at the expense of something more important: cash flow. Managing your cash is by far the single most important factor in business success. No amount of sales or profits can save a business from having insufficient cash flow.
Timing Is Everything
Cash and profits are different. There are many profitable businesses that flirt with bankruptcy because of a lack of cash. A contractor, for example, may win a $1 million contract with the federal government. The cost of delivering on the sale could be $800,000, leaving a profit of $200,000. An owner that solely looks at profit would be very happy with this deal. But if we take a closer look, this deal may doom the company. Let’s assume that the company has exactly $800,000 in cash and credit available, which it uses to deliver on the contract. Many government contracts don’t allow you to invoice until the work product is delivered and approved. If that process takes 90 days, then the company will have zero cash reserves during those months as it waits to collect on its $1 million invoice. While the contractor is waiting, bills still need to be paid: rent, salaries, software licenses, insurance and more simply can’t wait three months before the contractor collects. Everyone wants to get paid now. Unless the contractor can generate enough cash from other sources during those 90 days, they many find themselves out of business before they ever collect their payment from Uncle Sam.
If you want to avoid this nightmare scenario, you must make cash your priority. It’s possible that an emergency like your biggest client going bankrupt or losing a lawsuit will lead to a sudden cash shortfall; however, most companies that die usually do so from cash flow problems that have built up slowly over time.
Stop The Cash Bleed
If you're concerned about your business’s cash balances (and unless you're Apple or Berkshire Hathaway, you should be), consider taking these steps to address the problem head on:
1. Review your cash balances. It’s important to have at least 90 days of operating expenses available in cash. If every single client or customer stopped paying you today, could you last three months?
2. Secure revolving lines of credit. “Revolvers” are basically credit cards for companies. Financial institutions issue these lines of credit, which allow you to draw down as needed. The best time to secure one is when your company needs it least. You’ll find it difficult to secure financing after you become desperate. Your revolver can complement your cash balance to ensure at least 90 days of expenses.
3. Stop paying all of your bills on time. The reality is that not all supplier and providers have to be paid on time. Many companies are willing to offer you terms that can give you a little extra time ranging from days to months to pay your bills. Make a list of every person and company that you owe money to and see how far you can push paying on time without any adverse effects.
4. Conduct a cash flow analysis of every customer. In addition to preparing an accounts receivables schedule, you should also prepare a cash flow schedule per client. Analyze the timing of the cash in and cash out associated with each one. For those clients that generate negative cash flow, it’s time to negotiate with them. Either change the timing of the payments or charge them for the financing costs associated with the cash flow imbalances. Keeping customers that require you to spend cash upfront and wait for payment down the road are a risk and should never represent the majority of your business unless you have steps 1 and 2 secured.
5. Set up alerts or use a dashboard. Cash flow isn’t something that you can monitor quarterly or even monthly; it has to be daily. Use automated alerts and or a management dashboard to incorporate cash balance reviews into your daily routine.
If you still doubt that cash is more important than profit, ask any successful business owner if it’s a good idea to sacrifice cash flow for profits and you’ll have your answer.
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