Cash Flow vs Profit – Part 2
Last week we talked about cash flow and profit and why it’s important to understand the difference between the two.
We also looked at an example which illustrated that even when a business is profitable it can still have a negative cash flow. And whilst profit is of course important and should be a big-picture goal for any business, it’s cash flow, or rather the lack of it that will give you sleepless nights.
Therefore, paying attention to cash flow on a daily basis is vital if you want to ensure the success of your business.
So, this week, we’re going to look at some ways of improving cash flow.
How can you become cash flow positive?
Assess your current situation
Start by calculating the cash coming in and the cash going out of your business by following these steps:
- Calculate the value of all your revenue each month. For instance, if you run a consultancy business and have four clients with an average monthly invoice of £5,000, that means your total revenue is £20,000. Unfortunately, one client hasn’t paid your invoice as yet. As a result, you have actually only received £15,000.
- Calculate your cost of sales and your operational costs. For example, your consultancy business may have £5,000 in cost of sales in addition to which there are operational costs such as salaries, rent, telephone etc. of £10,000. So total costs for the month are £15,000.
- Calculate any other expenses, such as loan payments. Be sure to include everything related to your business. Let’s say you have a business loan costing £2,000 per month.
- Calculate whether you’re cash flow positive or negative. Altogether, for this particular month you have £17,000 going out, but because one client hasn’t paid their invoice you’ve only got £15,000 coming in.
At the end of the month, you’re cash flow negative, as you’ve spent £2,000 more than you’ve actually received.
The advantage of doing this exercise is you begin to get a clear understanding of exactly where you stand month on month.
Now you know where you stand, you can begin to take steps to get or stay cash flow positive.
Here are some other ideas
It sounds obvious, but increasing revenue is a great way to start improving your cash flow. There are 3 main ways to increase revenue and I covered these in a series of blogs I wrote a few weeks ago called “There Are Only 3 Ways to Grow Your Business”.
Take a look as they will give you some great ideas.
Ensure clients pay on time
It is estimated that over 60% of small businesses are regularly affected by late payments, so this is a big issue for business owners.
Perhaps start by looking at ways of changing the way you operate the business. Decide that you will ask for a proportion of monies as an upfront payment. Send polite but firm reminders when the final payment is due and charge a late payment fee if you feel that’s appropriate.
We in Britain don’t always like talking about money, but I’ve found having an open and frank discussion with a prospective client right at the very outset helps manage both the client’s expectations as well as yours when it comes time to pay.
Always remember, you’ve done the job. You deserve to get paid!
Build a buffer
During the months when you’re cash flow positive, make sure you put some funds aside for times when business might be slow – you are just saving for a rainy day.
As a guide, work out your monthly operating expenses and look to build a buffer of up to three months’ worth of operating expenses. You may not be able to get to that figure straight away but have it as a target and gradually build up.
Are there ways you could reduce the costs within the business? Perhaps you’re spending too much on rent. Review your situation, look at other options and perhaps decide to downsize or as is common nowadays, share a workspace.
Are you spending too much for utilities – telephone, gas, electric, mobile. It soon mounts up. See if you can get better deals.
Essentially, look at all your business expenses. Look at ways to spend less without affecting your business. I can guarantee you’ll find waste and be able to cut expenditure.
Don’t forget about HMRC
PAYE, Self-Assessment, Corporation Tax. All need to be paid.
But don’t wait until a few weeks before it’s due and then start trying to find £10,000 to pay your tax bill. That really will play havoc with your cash flow.
Instead, put monies aside each month to cover future tax bills. If you’re not sure how much to put aside, ask your accountant. And remember, this is not “rainy day” money you can dip into when cash flow’s a bit tight!
We’ve all been there and as I’m sure you are only too well aware; cash flow is vital for both the survival and success of any business. Therefore, part of our job as business owners is to take a long hard look at our business and see how we can improve cash flow.
It will enable you to plan and then grow the business. Not only that but a positive cash flow will do wonders for your sanity as well!