Definition of Cash Flow:

It’s a simple concept, Cash flow is the amount of cash (not profit) your business has to operate.  Usually counted over a specific time period (a month, a quarter) it is the cash which comes in from sales, investments, loans, interest and other sources minus the amount which goes out for expenses, to buy inventory – whatever you are paying for.

Cash Flow and Hundred Dollar Bills CycleFor most entrepreneurs, cash flow is what the business runs on.  Whether you made a profit for any given period is a different question. It’s the cash in, cash out of the organization that keeps it alive. If you can pay your people and pay your bills, you keep operating. When you can’t meet obligations, something has to change.

I’ve been consulting for nearly thirty years and the first question I always ask a business owner is “What is your major problem?”. In the US, the answer is “Cash Flow” by a huge margin.  As a consultant this doesn’t tell me much: only that the business is having trouble meeting bills and payroll. The reason it doesn’t tell me much is that cash flow is usually a symptom of a larger issue. Below are a few popular reasons for problem cash flow.

YOUR PRICING IS WRONG

I’d say this is the #1 culprit.  Too many owners are pricing to the market without regard to their own expenses. They believe that pricing above competitors will cost them sales.  Possibly. But if you are losing money on each sale, how is this furthering your ends?  As a small business you cannot compete on price most of the time because you do not have either the economies of scale or the ability to make advantageous deals with suppliers. You have to find another way to compete. (Under marketing you’ll find a section on competition.)

How much do you need to charge to make a profit?  Surprisingly few owners know.  They have come up with some formula (“I double what I paid for it and add 10% “ or something akin to that) which has no basis in reality. We’re going to give you some very simple tools to figure out how much profit you make at various price points.  

I’ll leave you with this: the deli in my area is almost twice a expensive on some items as the local grocery store, yet they have been in business for 30 plus years. 

YOU JUST DON’T HAVE ENOUGH MONEY

If the business has high expenses the volume of sales required to meet those expenses may take a long time to reach.  I’ve seen this often when a company opens with a sizeable staff (or an expensive one), a high priced facility, high value inventory, etc, etc. and is unable to meet expenses as a result.  The hope is always that you will meet sales objectives soon. What if you don’t? 

You need to bite the bullet and shave the expenses until you can realistically afford them. Unless you have concrete evidence that sales will spiral up in the short term, be very, very cautious about borrowing to meet operating expenses, particularly if it involves mortgaging your home.

LOW GROSS MARGINS

Gross margin is the revenue from your goods and services minus what they cost you to make and sell. (See the section on Using Your P & L to calculate your Gross Margin). It does not include your overhead, but does include all the expenses directly related to selling your product.  Your gross margin must be large enough to cover all of your overhead expenses, investment in the business, unusual expenses and your profit.  The reasons Gross Margins are weak include pricing which is too low (see above), high cost of raw materials and high labor costs to name just a few of the more obvious. 

COLLECT YOUR MONEY

For some types of business, slow payment by customers can cause cash flow problems. This is particularly true for businesses which charge large sums (contractors, for instance).  Most people hate making collection calls but the only remedy is to get your customers to pay you. Think of it this way – they are maintaining their cash flow at the expense of yours.  

You may be able to mitigate the problem somewhat by devising a different payment method. Try collecting part of your payment on a regular basis as the job progresses. For instance, each Friday talk to the client, provide an update on the job and collect a portion of the total equal to the percentage of work completed.  

You can run a business on cash flow without profit for some time – not forever – but for a while.  It therefore follows that you need to understand your cash flow, when it’s in danger and what to do to remedy the situation. Right now, make yourself go to Cash Flow and download the Cash Flow Sheet. Start using it immediately. 

For those of you who sweat at the sight of columns of numbers, the first time is the worst – it gets easier over time.  If your accountant does – or will do – a cash flow for you, that’s useful only if you really understand it.  If the accountant can’t or won’t help you understand it, this is a clue you need a new accountant.

Take a look at or download our sample cash flow spreadsheet here:

CashFlow

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Or, If you would like a blank cash flow worksheet to use, click here:

BlankCashFlow

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