Go With the Flow

A healthy profit may not mean a healthy business if poor cash flow leaves you with too little money on hand to meet your regular obligations

Chuck’s business makes a healthy profit. George’s business has a strong cash flow. Who is better off?

Answer: It depends. Profit is essential for your business, but without good cash flow, you could still wind up in big trouble. And don’t mistake one for the other.

Profit is the money left over after you pay all your expenses. Cash flow is the interplay of money coming in and going out over time. Let’s say it costs you $250 to do a job for which you charge $350. That’s great profit margin: better than 28 percent. But suppose you bill the customer in March, and you don’t get paid until June. Or suppose you bill out $10,000 worth of work in a month, but the payments dribble in over three months.

That’s lousy cash flow. Month after month, you’ve had to pay for supplies, fuel, wages, the lease for your building and more. And don’t forget estimated tax payments. If your cash flow is poor, you may not bring in enough to pay those bills when they’re due.

So what happens? You may have to tap your business line of credit to cover the shortfall. The interest you accrue can add even more expense. And yet on paper you are making a solid profit.

“If too many of your customers begin to be late paying you, you can feel that pretty quickly,” says Don Shultz, controller for Newcomb Marketing Solutions in Michigan City, Ind., and the Leaders’ Resource Network (LRN), which provides business advice to companies in the environmental service industry. Shultz was a speaker during the daylong LRN seminar series at the 2008 Pumper & Cleaner Expo.

So how do you master and improve your cash flow? Here are five steps.

1. Map out your income and expenses.

Look at the last calendar year, or even the last two or three, and track your income and your expenses. A cash flow report can cover any period of time, but the most useful one goes from month to month. Specific designs can vary, but a typical one is shown in the accompanying table.

For a really big-picture view, you could combine a whole year’s data in a single column. On the other hand, if you’re just starting out and cash is really tight, you might want to expand this to take into account individual weeks or days of the month.

Keep in mind that all the numbers in the document should be in real time. Sales, for example, shows the money that came in from customers who paid that month, not what you may have billed that month.

2. Analyze the results.

This imaginary business had a little upsurge in February, while its costs remained constant. In March, however, things went the other way. Payment on work billed in February was slow to come in, so the sales line took a dip. At the same time some payments went up.

It looks like March actually continued a busy streak. The upsurge in payroll probably reflects overtime expenses from a flood of new calls. Expenses on supplies went up, too, to replenish the stocks used in February and March. And overhead soared, probably for the additional fuel spent on all those extra calls in March. The bottom line: At the end of March, the cash is below water at a negative $1,600. A negative cash position is a bad place for a business to be.

By April, things have begun to recover. The income from all that extra work in February and March has begun to come in. Payroll has settled down, and expenses for supplies have reverted back to the usual pattern. The cash balance is back in positive territory. And in May things look healthy again, although the cash shortfall from March is still working its way through the system.

It’s not hard to see that tweaking a number here or there could set things seriously awry. What if that April income didn’t bounce back? What if someone quit in March, and to hire a replacement, the company suddenly had to pay a lot more money, driving up the payroll costs even more than the overtime? Or what if gas prices increased permanently, as they have in real life? That would probably push overhead higher and keep it there.

3. If your cash flow is poor, consider why.

Remember, cash flow has two components: expenses and income. Take expenses: Not every bill comes once a month. Some, like insurance premiums or property taxes, come once or twice per year, but when they do arrive, they take a big bite. On the income side, a chief cause of poor cash flow is customers who don’t pay on time. Another term for that is “aging receivables.”

4. Look at strategies to improve.

Suppose your cash flow is generally good until December, when your property tax bill arrives. That’s a problem you can easily solve, says Shultz. “At the end of the year, you have this bill hanging out there,” he says. “You need to have the cash to pay that when the time comes. So you really need to expense that each month and save up for it.” To do that, you can create a special account and set aside one-twelfth of the year-end bill each month. Then when the bill arrives, you can pay it without much pain.

Or suppose the real problem is how money comes in over time. A more sophisticated cash-flow analysis can help you see that your customers are typically taking 45 to 60 days to pay. In that event, you need to speed up payments. To do that, you can:

• Start taking credit cards.

• Institute a policy of billing at the time of service rather than sending the bill later.

• Shorten your payment terms. Some contractors offer terms as short as net 10 days instead of the standard 30 days.

• Slap on penalties for overdue bills; 1.5 percent per month is typical.

• Don’t let late bills linger. Send out second notices or call to check after a reasonable time.

“If you do a lot of billing, you really need to stay on top of and manage your accounts receivable,” Shultz says. “If they’re outstanding 45 days, you need to call them right away. People are going to pay the squeaky wheel first.”

5. Project the future.

You can never be sure how business will go tomorrow or next year. But with enough past information, and with good projections of how costs like wages or fuel prices or supplies will go up, you can make reasonable estimates about next year that allow you to set aside money in the fat months to smooth over the lean ones.

If you aren’t already subjecting your business to a regular cash-flow analysis, it’s time to start doing so. The insights you gain will help your business run more smoothly and help you put more money in the bank.



Discussion

Comments on this site are submitted by users and are not endorsed by nor do they reflect the views or opinions of COLE Publishing, Inc. Comments are moderated before being posted.