Cash Flow if you re out of money, you re out of business.

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1 Cash Flow if you re out of money, you re out of business. Thanks for downloading this Cash Flow Cheat Sheet from SmartBusinessPlans.com.au Cash Flow is probably the most important aspect of keeping a business alive, so it s important you have a good understanding of the basic principles. I ll cover that in this cheat sheet, as well as my top tips for managing cash flow in your business, based on the first hand experience I ve gathered from working with hundreds of business owners and managers around the world. Basic Principals of Cash Flow When I talk about cash, I mean the money you have sitting in your bank account at any point in time that is available to you. That s money that hasn t yet been spent on wages, inventory, rent or any other costs, purchases or taxes. Take the example of a glass of water revenue is cash coming into your account, filling your glass up. Costs are cash leaving your account, draining water out. The aim of the game is to always make sure you have water in the glass. If you run out of water, you usually go out of business. This is cash flow managing the flow of money into and out of your business in order to make sure that there is ALWAYS water in the glass (surplus cash in the bank). The Revenue Trap There is a very important trap to avoid with revenue. Most people assume revenue is generated when you sell a product or service. This is not true. Revenue is generated when you get PAID for the product or service. For some businesses, this is immediate for example if you buy milk from the supermarket, you pay on the spot. This should be the goal for your business. Many types of businesses however get paid after they sell their product of service. Consider an architect firm for example. They produce designs for a client, then once the designs are completed, they invoice the client with payment terms of 14, 30 or even 60 days. So while the architect waits to get paid, he still needs to pay his costs (staff, materials, utilities etc). This is a position you want to try and avoid if possible.

2 Tips for Getting Paid Quickly Ok, so here some strategies you can employ in your business to greatly improve your cash flow position: 1. Get paid up front, or at least get a deposit. I know in some industries this isn t the done thing, and you may have competitors offering generous payment terms, but that doesn t mean you should automatically follow suit. If your clients trust you and consider what you offer to be valuable, then the risk of losing business by requesting payment up front is reduced. If nothing else, at least consider getting a deposit. 2. Invoice projects and services in stages. If you aren t getting paid in full up front, then you should aim to invoice for products and services that are delivered in stages in instalments. Make sure you clearly define the stages of the product or service, and set expectations that the following stage won t be delivered until the previous stage is paid. 3. Invoice quickly once payment is due. Some businesses run all their invoices at the end of each month. I think this is crazy. Say a client owes you money from the 4 day of the month, but you don t issue that invoice until the last day of the month. Then on top of that you offer 30 day payment terms. That s something like 8 weeks you will be waiting for payment, assuming they pay on time. Always invoice as soon as payment is due. 4. Provide an incentive to pay quickly. I ve seen this work really well in a number of businesses. For example, offer a 2% discount if the client pays their invoice before the due date. Weight up the cost of offering this discount against the cost and time you need to allocate to chasing late payment. In addition, impose a 5% penalty for late payment (which can also increase after a period as well). This is the carrot and stick approach. 5. Make it easy for customers to pay. You very rarely stop to think about how your invoices are laid out and formatted, and often they are auto-generated by financial management software. But go and have another look at your invoices. Are they easy to read? Are the payment terms clear and easy to see? Are your bank account details easy to find? Do you offer credit card and PayPal options for small amounts or infrequent customers? 6. Always call to confirm receipt of invoice. Don t just or mail an invoice and then forget about it. Always call the customer the following day and check that they received and understood the invoice. Also use this call to double-check you have sent the invoice to the right person (ie the person responsible for paying), avoiding any unnecessary delays. 7. Work with late payers. When you have a customer who is late on payment, you can either bring out the big guns (lawyers, debt collectors), or you can try to work with them. I d recommend at least trying to work with them, as getting some of the money is better than none. Think about establishing a payment plan that the customer can work to and that is acceptable to you. 8. Check credit history. Always check the credit history of a new client so you know what to expect. If there are issues in their history, only work with them if they pay up front.

3 The Cost Side of Cash Flow Management Here is one really important principal to know when looking at the cost side of cash flow. Profitable businesses can still run out of money and go bust. Doesn t sound quite right at first glance does it? I mean, we all know that if a business is profitable, it must be earning more money that it s spending, or it must have more revenue than costs. So if it is earning a profit, it must have surplus cash in the bank. So how come these businesses can still go bust if they are profitable? Look at the diagram below to find out why. This is a classic view of how a traditional retail store would see cash flow through the year. Each column above represents a month of the year, blue highlighting revenue, red highlighting costs. Lets say that the blue columns equal $100 in revenue, and the red columns $90 in costs. So over the course of the year the business earns a $10 profit. So if business is making a profit there are no problems right? You guessed it, there is a problem, which I ve circled. As with most retailers, this business has its highest revenue period around Christmas (Nov-Jan). But in order to have enough stock to sell in Christmas, it needs to purchase inventory in August and September. The problem is that it doesn t have increased revenue in August or September. So unless they have planned ahead and recognised the lag between incurring the costs, and bringing in the revenue, they could be in trouble. This is what cash flow management really is looking ahead and working out how much cash you need in the bank at any particularly time to keep the business running. The Giant-Killing Rule about Costs The statistics tell us that something like 70% of new business don t last more than 5 years. But did you know that HALF of these businesses fail because they were too SUCCESSFUL? Let s stop and think about that for a second. Half of the businesses that fail do so because of growth, not because of a lack of sales.

4 Whoa... How does that work? Well, it all comes down to managing costs and cash flow. The problem these businesses faced was they grew too quickly. They started receiving more and more orders and customers, and to fulfil those orders their costs started to escalate. But due to a lag between fulfilling orders and getting paid, they ran out of money in the bank at a point in time, and couldn t bridge the gap. So let s look at how you can manage costs better and avoid this trap. Tips for Managing Costs 1. Negotiate favourable terms with suppliers. This should be at the heart of your cash flow strategy. You should be aiming to set up a cycle where by your customers pay you immediately (or quickly), and you take as long as possible to pay your suppliers. This puts you in the strongest cash flow position possible. 2. Inventory don t hold too much. Any excess inventory you are holding is cash that could have sitting in your bank account. Unfortunately you can t pay your electricity bill with a store room full of coffee beans, so don t hold any more stock than is absolutely necessary at any point in time. 3. Consider leasing. Do you really need to buy your point of sale system or your office furniture outright? While you may pay more over the long term by leasing, there are many potential tax advantages to leasing, as well as the advantage of not spending all your capital up front on business assets. 4. Outsource if it makes sense. You can outsource nearly any part of your business these days. You need to decide what you are comfortable outsourcing, and what you are not. For the outsourced parts of your business, you ll have much greater flexibility over how much cost you want to incur each month, as opposed to an in-house full time staff member who always needs to be paid regardless. 5. Work with the tax department. Be proactive with the tax department. If you are having problems paying a tax bill call them and ask for a payment plan. They are much more likely to work with you if you proactively work with them. 6. Work with the bank. Develop a strong relationship with your bank. Set up overdraft and line of credit facilities from the outset so you don t have to run into the bank one day for an urgent cash advance because you ve run into trouble (that tends to make them nervous ;>) 7. Don t be afraid to ask questions. Too many businesses go bust each year because their owners never understood what was really happening. Ask questions, lots of questions, because there are no dumb questions when it comes to your business.

5 How you can Predict the Future Now that I ve taken you though the strategies for managing cost and revenue, let s bring this all together and figure out how to predict the future, avoiding a lot of the common traps for business owners and managers. The magic tool that helps you see exactly what your bank account will look like at any point in time (or how much water you have in the glass) is called a Cash Flow Forecast. A Cash Flow Forecast is a tool that accountants and banks use, but that doesn t mean you shouldn t be using one too. In fact, having your own cash flow forecast tool will improve the way you communicate with your accountant and give you a far greater understanding of your business. As the name suggests, a Cash Flow Forecast is a prediction based on your assumptions. It is typically a spreadsheet that allows you to plug in all the costs that you will incur each month, and all the revenue you expect to bring in that same month (remembering that a sale this month might not bring in revenue until next month). It then calculates how much money will be available in your bank account, and highlights any periods when your balance is likely to be negative (or when you won t have enough money in the bank. By knowing this in advance (Cash Flow Forecasts usually look ahead at least one year) you can put in place your plan for managing the business through problem periods. It might be you can reduce costs that month, or bring revenue in more quickly, or look to the bank for an overdraft. The point is that by developing and managing a Cash Flow Forecast, you are in control of the success of your business. For more information on business management, business planning or cash flow forecast development, visit: Chris Connell Smart Business Plans