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Understand your business’s cash flow and grow your profits

Guest post by: Joseph Lizio

Article Overview: By not understanding your business’s cash flow – what it costs to obtain revenue and where those funds end up – will only lead to the decline and demise of your business efforts. If you want to increase profits, you have to manage your business finances.

Understand your business’s cash flow and grow your profits

Several years ago when I was a commercial lender, I met a young lady with an outstanding business. She and three partners were providing home healthcare services in their immediate and surrounding area. She came to me in search of a working capital loan as the business, while making over $100,000 per month, was struggling to pay all of its bills. After spending some time with her going over the business and its financials, she came to the realization (something that I was trying to demonstrate to her) that she did not really understand her cash flow.

While she was pretty astute regarding the revenue that was flowing into her business - she had no idea where that money was going or for that matter what those funds should be used for.

An example, they recently accepted a contract for services at an assisted care facility that paid them over $20,000 per month. However, the service location was some 60 miles from their home office. After several months into this contract, she could not understand why they were struggling to meet payroll and other bills.

What we quickly determined was that while the $20,000 per month income was great - it was costing the company over $30,000 per month to service that contract due to travel and transportation cost as well as payroll, insurance and overhead. You would not believe the shock on this young lady's face once that comprehension set in. Until this point, she had only ever looked at the top line revenue number of the business in general and never once thought about venturing deeper into her financial numbers - especially matching revenue per job to costs per job.

The lesson here is that all business owners really have to understand what the cash flow inside their business is doing - especially growing businesses that, time and time again, grow themselves broke in part because they do not understand how the individual costs associated with each dollar flows through the organization.

Understanding your business finances is as simple as creating a financial reporting system that is easy to understand and provides relevant information. Examples of relevant information could be as simple as (just for starters):

-Which customers are paying and which are not to include who is paying late.

- What each customer or contract or product is costing the firm (variable costs either per product or per customer).

- General overhead of the business and its trend.

- Profit margins - is there enough profit (revenue above variable costs) to cover overhead, taxes, interest, etc as well as provide a cushion for the business to pay owners, investors, other stakeholders or to be simply plowed back into the firm for growth and development. Not to mention the healthcare costs that will soon be mandatory.

Now, if you do not have the financial or accounting wherewithal to create your own financial reporting system - there are many accounting software products that you could easily incorporate into your current operating systems. There are some very simple programs that are free for business owners but require some level of account knowledge to manipulate the inputted data and extract information as needed. There are also some commercial programs that are quite expensive but really take a lot of the burden off the business owner. And, lastly, there are some in between.

Regardless of what you use - do use something! The alternative is to ontinue to lose both time and money wondering where your business is headed - up or down and what your money is doing (you want it working for you - not against you).

These systems, whether created or purchased, really do pay for themselves. As my example above outlines, had this young lady and her partners had a better grasp on their business finances, they would have never agreed to that $20,000 contract (either asking for more money to service the contact or just declining the offer and putting their efforts into a more profitable direction) and surely would not have been in my office asking for money to meet their daily expenses. (Keep in mind that since they agreed to a two year service contract - they had to continue to service that assisted care facility while they lost over $10,000 per month doing so).

The moral is that knowledge and information are power when it comes to the finances of your business. Understanding your company's cash flow can help you avoid situations like the one described here as well as give you more tools to ensure that you are taking your business in a most profitable direction - which is the goal of any business owner - to make as much profit as possible.

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Article Tags: accounting systems, cash flow, costs, finances, management, profits, revenue, small business



Related Forum Posts
Re: Service Or Product? - I usually recommend starting with a service to get close to your customers, bring in cash flow, and keep your overhead low. Step 1 of entrepreneurship is getting past survival and being able to pay your bills without taking a job. A service is a great way to get you started and really get to know your customers and their problems. But it's a lot harder to scale a service business so if you really want to grow you can then focus on the product side of things. You have cash flow from the service business and a keen understanding of the pain in your market as well as a history of successful clients who have worked with you and can provide valuable testimonials.
Tax returns! - Well, this is new on me. i had no idea you could sell a site off. If it's anything like purchasing a non-internet business then you need to check into multiple things. Will you need to finance to purchase? If so, you'll need to calculate the cash flow. Also, find out if there will be any add backs to the cash flow, for example, are there other workers invovled to keep the site running...perhaps workers you won't need when you take the site over? Their salaries can be added back to the cash flow if you will not need them. You must see the top page of the last year tax return (never go off just the P & L's). Did the seller run anything personal thru the tax returns that you wont? That's also considered an add back to the cash flow. What is the gross sales for the 12 months? What is the net income for the 12 months? Make sure the purchase price is justified. You can calculate a ball park range on this by doing 30 - 50% of the gross sales for the year or 3- 5 times the net earnings. What is the web traffic like? Is it steady? Do you have time to run the site or will you need to hire someone to manage it? Make sure the business is supporting itself and is profitable. Does the seller have an initial business plan from when they bagan the business, so you can look it over?
Re: Interrealtionship between financial statements - Yes, it’s necessary to take a complete toll of account transactions. If you don’t, then how would you be able to track your financial figures? For example, If a person sold goods for USD 5,000.00, half in cash and half in credit, then with taken impact of all three i.e. cash flow by USD 2,500.00 balance sheet through both cash and receivable and income/P&L statement by USD 5,0000.00, the transaction will not be complete.
Improve your Cash Flow - As we all know, the primary concern of proprietors and managers are cash flows. I would like to share some tips on how to improve the cash flow of your business. 1. Speeding up Collections - collecting receivables earlier, on or before due dates. Discounts for early payments can be one way to do this. 2. Slowing Down Payments - stretch your payables and pay only when it is due. But be careful not to mess up with your credibility. 3. Invest in Marketable Securities - use the money in Marketable Securities and other short-term investments to earn extra cash.
Topics of Interest - There have been some wonderful resources posted in this section. However, I also strongly advise any entreperneur to pick up a few books on personal financial planning; cash flow is key to any business and the best way to start planning good cash flow for your business is to learn some personal financial planning. I have always enjoyed the following: The Millionaire Next Door- Thomas Stanley and William D. Danko Richest Man in Babylon- George S. Clason Rich Dad, Poor Dad- Robert T. Kiyoski and Sharon L. Lichter There are many many more great resources on this topic. These should be read in conjunction with the other resources posted here. Good luck.


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