Ways to Improve Cash Flow (Part 2 of 2)
4. Lines of Credit & Cash Reserves
Having access to cash during times of distress can be life-saving. The global pandemic showed us how important it is for owners to have the cash flow to maintain operations during slow revenue periods. The businesses that couldn't access cash for payroll or bills struggled to maintain operations, and sadly many businesses had to close because of this. Because "cash is king", let's talk about how to access cash if there's an emergency, slow sales period, or an investment opportunity.
Get a line of credit before you need it. If you are an established business with a proven revenue stream, apply for a line of credit at your bank. Leave it open, but only use it for short-term funding. These are usually at a lower interest rate than a credit card and can be paid back on flexible terms. Don't rely on it for daily operations. Think of it more as that safety net that's there if you need it.
Ideally, however, a business should have 1.5-3 times operating expenses ready in an emergency savings account. For example, if your monthly overhead is $10,000, you'll want an account that has anywhere from $15,000 - $30,000 easily converted to cash. However, some experts recommend having more than 3 months' expenses in the bank. The amount of cushion you need depends on many factors that only the business owner can decide.
5. Tighter Inventory
If you sell products, you need to understand how inventory affects your cash flow. You use your cash to buy products and then turn around and sell those products to your customers. Ideally you would sell everything really quickly and then have cash from your sales to pay bills and order more products. The inventory cycle has a huge impact on your cash flow. You never want to have too much inventory just sitting on your shelves, and you don't want to upset your customers by having too little inventory.
Inventory is an asset on your balance sheet, but it becomes a liability if it just sits there and isn't sold in a timely manner.
Here are some ways to find the right balance:
Track your sales down to the penny. Use software to do this, if you must. You want to know how much and when you sell products.
Knowing your sales patterns will help you to properly forecast the amount of inventory you need to keep on your shelves. Use a spreadsheet or software to determine the amount of product you will need to have in the future months. You can then back track and plan for when you need to order from your supplier. This helps you plan for the amount of cash you'll need to pay for your items.
Negotiate with your supplier to possibly buy large orders in smaller amounts. If you get a discount for wholesale, ask if you can break it up into smaller orders and still get the discount.
Look into a fulfillment system if you have trouble processing orders from customers. These large warehouses will store your inventory and ship directly to your customer for you. This is oftentimes more expensive than holding the inventory yourself, but it can help with the inventory and supply problem and keep customers happy.
Carry "buffer stock" for high demand items.
Analyze your inventory periodically. Items that aren't big sellers may just be taking up space in your business. You also want to look for items that are not profitable. For better efficiency, make sure you are focusing your efforts in the products (and services) that are most profitable.
6. Converting Capital Costs
To lease or to buy, that is the question. I often talk to business owners who think that in order to build their business asset portfolio, they need to buy everything from the building to the printer. Unfortunately, most capital expenditures depreciate and require a large outflow of cash. This can be stressful and an unwise move for business owners.
I challenge owners to think about leasing instead of buying.
Benefits:
Small cash deposits usually required for a lease, depending on the type of asset
Can write off the lease payment as an operating expense on your taxes
Can write off the depreciation as on your taxes
Many times the owner is responsible for maintenance, should anything go wrong. Or if the lessee is responsible for "ordinary wear and tear", it's minimal compared to having to maintain the asset and being wholly responsible for the life of the asset
Drawbacks:
Can be more expensive if you are keeping the equipment long term
Here's an example:
Two clients need a new truck for their construction business. They each find the perfect kind of truck that retails for $100k.
Client A: Buys the truck outright, putting $50k for a down payment by trading in an older truck and supplementing with cash. She takes out a loan for the other $50k at 0% APR through the dealership. She buys the 5 year warranty.
Balance Sheet: Debit $50k cash, Credit $100k truck asset, Credit $50k Accounts Payable
Cash Flow Statement: Depreciation - accountant only tracks it once a year, even though accrual accounting
Client B: Takes out a $100k lease at 2% APR.
Balance Sheet: Debit $1500 cash for this month's payment
Cash Flow Statement: Operating expense monthly payment $1500, written off at the end of the year against net operating income. No deduction of depreciation
So which client fares better than the other? Ultimately the cash flow with Client B is relatively unaffected, even though he is paying 2% APR on the life of his lease. This frees up his cash to be able to meet other obligations such as payroll, bills or investment opportunities. Client A will have less cash at her disposal to be able to meet such obligations. She may even have to miss out on some future investment opportunities.
7. Owner lifestyle
Owners who cannibalize their company's profits or cash flows are ultimately doing themselves a disfavor in the end.
I've met many clients who write off their personal lifestyle expenses as a business operating expense. This is disadvantageous to them in the long run because
When negotiating the exit valuation, the financial statements all need to be redone with the proper net operating income disclosed to the buyer. This process can be time consuming and expensive.
Rather than using the company's profit for additional capital expenditures, scaling, or expansion, the cash is used to fund the business owner's lifestyle. Growth is stagnated.
Recessions and slow periods of revenue become very dangerous because the company lacks additional cash to get them through tough times.
To improve cash flow for a business that typically funds an owner's lifestyle, there are a few things that can be done.
Keep personal and business expenses separate. This is a smart strategy not only for your relationship with the IRS, but for profit and cash flow as well.
Hold on to profit in the business to help you strategize future plans. Profitable companies use their cash flow wisely to not only get through the tough times, but grow and ultimately sell to another buyer.
Pay the business owner a fair wage for her services and responsibilities of the company. What would you pay another CEO to come in and replace you as the owner? Would you let that person write off personal expenses for the business? Most of the time, the answer is "no".
Healthy cash flow is vital to any company, whether experiencing rapid growth or not. As a business owner and the CFO of your company, you need to acutely aware of every dollar that is flowing in and out of your business. Don't assume that high revenue and profitability alone will keep your business alive. Many companies have wrongly ignored cash flow patterns, which have led to their ultimate demise.
If you need help forecasting and analyzing your company's cash flow needs, hiring a fractional CFO can give you an immediate and valuable return. Set up an appointment today by emailing hello@audaxwealth.com and get started on improving your cash flow.
