In my opinion, two words sum up the most important factor in a successful business. The earlier you are in the life of your small business, the more true this becomes. Today I'm talking about cash flow.
Sales are important. Profits are even more important. Cash flow is infinitely more important than both of those. You can sell 1,000,000 gadgets and lose money. You can show $1,000,000 in net income on your income statement but not collect enough of the customer payments and go bankrupt. At the end of the day, having more cash (ie. actual money in the bank) come in than goes out is the way you will stand above all of those other small businesses that fail each year.
Of course, that's often easier said than done.
Instead of listing off all the ways to mess up your cash flow (I’ve seen too many to list), let’s go over some simple ways to keep the lifeblood flowing through your company.
1.DON’T SPEND ALL OF YOUR SEED MONEY
If you are lucky enough to go into your new business with some cash in hand, hold onto it like it's the last money you will ever see. In the venture capital world, a term they use is runway. Runway is how long (usually expressed in months) you can operate your business if your current income and expenses remain the same. So, if you had $100,000 in the bank, and you were currently losing $10,000/month, you'd have 10 months of runway.
A problem I see quite often is new business owners spending too much, too soon. Either they have more money in the bank than they're used to, or they want to make their business look more successful than it really is. They'll buy a new truck, a new computer, rent a big office, and fill it with new furniture.
I know using your old truck, old computer, and running your business from the kitchen table isn't very sexy. It's much less sexy when you run out of cash and they repossess your Aeron chair.
2.REDUCE OR ELIMINATE ACCOUNTS RECEIVABLE COLLECTION TIMES
This is so important, especially early on, but can be so hard to get right.
If you can, get paid up front. If that's not realistic, take a 25-50% deposit before starting any work, and don't release the final product before getting the final payment. If you absolutely have to give a client terms, make them as small as possible. Instead of Net 30, try Net 10 or 15. Consider offering incentives for early payment. For example, 1-2% discount if paid within 5 days.
Far too many times I've seen owners get really excited when they land a 5 or 6 figure project with a big company. Unfortunately, many of those big companies take at least 30-60 days to pay their bills. Suddenly you've got all your time wrapped up into one client, tons of project-related costs to pay, and no money coming in for months.
3.SETUP OR EXTEND ACCOUNTS PAYABLE TERMS
Now that I've explained how annoying it is to have clients who are slow to pay...I'm going to ask you to try to be one of them. Only do so if you can negotiate these terms in advance. Being a deadbeat isn't a good way to build up a reputation in your community.
If you have to buy materials or services from vendors, try to get the best terms possible. In the beginning, until you've established yourself, you may be forced to pay everything up front. Once you’ve established a good rapport, ask for terms. On small orders, see if they’ll give you Net 30. On larger orders, try asking for Net 30/60/90 to split up the order into 3 manageable payments. In addition, try asking for an early payment discount to save you some money when you do pay in advance.
The ultimate goal is to always have your customers pay you before you have to pay your vendors.
4.AVOID UNNECESSARY FEES
If you do the first 3 properly, this won’t be as big of a problem. However, if you start paying your bills late, you’re going to start accumulating late fees. Having poor cash flow will almost always lead to higher bank fees as well, since you’ll be paying interest on loans, credit cards, overdraft fees, and NSF fees that people with cash in the bank simply don’t have to pay.
5.RESIST THE URGE TO OFFER LARGE DISCOUNTS
So many business owners seem to have 2 buttons fused together. One button says "Panic", and the other one says "Discount". It seems like the second things start to look bad their first instinct is to drop their prices.
Please don’t let me hear you say; “We barely break even on every sale, but we plan to make it up in volume”.
Sure, once in a while it's good to offer promotions to attract new customers, but don't make it a regular activity. If you have a big sale every 3 months, smart customers will just wait until the next sale. Soon that sale price becomes the only price you're ever getting for your product or services.
6.PAY YOURSELF FIRST, BUT BE REASONABLE
Business owners usually fall into one of two extremes when it comes to paying themselves. They either play the martyr and never pay themselves, or they overcompensate and drain the company. The first couple years are going to be tough. You can’t expect to earn Fortune 500 CEO calibre salaries right away, but you also can’t do all this work for nothing. Find a reasonable amount that pays the bills, and stick to it. Pay yourself a set amount on a specific schedule, and don’t use the company as a personal bank account. Paying for personal expenses through the company makes bookkeeping a nightmare, and you always end up spending more than you think by doing it this way.
Oh, and when you do pay yourself, please remember to set aside some money for taxes. I've seen so many owners forget about this. They're used to having their taxes withheld by their employer, and they quickly get used to the larger payday. It's always a very uncomfortable conversation at tax time when I let them know how much they owe. How much to set aside will depend on quite a few factors, but 25% of your "salary" is always a good place to start.
Getting this right isn't easy, but it's very simple. Get paid as soon as possible, only spend money you actually have, and only if it will be used to help you make more money. Lather, rinse, repeat.
Running a business is hard enough. Doing it with cash problems sucks, and will sap the energy out of the most enthusiastic business owner. Follow these steps and you will see your business succeed where so many others have failed.