Find and Plug any Cash Flow Leaks in 6 Quick Steps
Cash flow has almost nothing to do with Profit!
A business can be profitable and still go bankrupt because of cash flow problems.
Profit is not the amount of money you have available in cash – your cash-flows, and your profit-flows are quite separate. Cash flow is having the right amount of cash in the right places at the right time, every time:
– Share Capital: investment into the business usually called capital or equity.
– Borrowings: from banks, other lending Institutions, or even individuals.
– Profit: making profits that generate new cash inflows
In contrast, the only way to make profit is by selling something for more than what it cost to produce; profit is the difference between the amount a business earns and the amount spent in buying, operating, or producing products and services. Profit often begins as cash but during the year is also often used to buy assets such as equipment, machinery, stock or to repay loans. When this happens your profit is no longer cash in the bank but becomes part of the overall value of the business.
For example if you make a bumper number of sales this month, all things being equal you will be more profitable than last month because you have sold more; but if you haven’t yet collected the payments for those sales, even though your books will show a lovely profit, your cash flow may well be terrible because you are still waiting for people to pay. To make it worse you probably have already paid for your stock and staff as you were making the sales.
* Processes and Terms
* Suppliers an Inventory Levels
Firstly make sure you are solvent: Can you pay your bills as they fall due?
If you are not able to pay your bills within their terms then you are insolvent trading this is illegal in most countries. Cash flow is the main trigger of business failures so it is critical to ensure you have sufficient cash at all times, or face the harsh reality that perhaps you need to “shut up shop”. As long as you are still afloat then targeting your cash flow is easy!
Next, to plug cash flow leaks, Ask and Answer these six questions:
Do you know exactly who owes you money and when it is due (and overdue)?
What you can change: From point of contact, right through to debt collection you are sending messages about how important your cash flow is. Accept payment via as many channels as possible, ensure you have eftpos, take credit cards, cash, cheques etc. Plus, keeping your accounting system up to date with both invoices raised and payments received avoids chasing (and annoying) customers who have already paid.
Will your debtors continue to pay at the same pace (Faster or Slower)?
What you can change: Choose your customers carefully – and be very clear about what you expect. Don’t be afraid to walk away it is better to have no customers and spend your time building a good pipeline of excellent new customers than DONATING your efforts for non-customers who WILL NEVER PAY!! Unfortunately late payers are common and chasing them is not fun! Collect Debtors Sooner.
Will you stay within your Overdraft Limit for the coming year?
What you can change: Good forecasting of cash needs and good decisions to stay within your cash capabilities. The easiest way to do this is to have a budget, ensure you use that to create a cash forecast and carefully monitor how you are progressing against what you predicted. Even for a tiny business creating these tools is vital to both manage cash flow well and to help secure finance if it is needed. Before you do watch out for pitfalls – and check out Quick Cash Flow Fixes can bring problems too!.
4. Processes and Terms
Are your Internal workings creating issues?
What you can change: Create and enforce very clear payment rules in your terms and conditions, AND ensure you follow up in accordance with your own process. This blog article has more tips Better Invoices get paid quicker!.
5. Suppliers and Inventory
Do you actively control your cash outflows?
What you can change: Negotiating the best terms possible with your suppliers is a good start. At the very minimum ensure your terms of payment to your suppliers match your terms of payment from your customers – so you align your expected receipts from sales with your expected outlays. Also look at how you can reduce stock and inventory – for example “Just in Time” ordering processes will both reduce your stock and your storage costs (but watch out it may also come with short payment terms).
Are your staff mindful of your Cash flows?
Do you have any other suggestions on how to plug cash flow leaks?
Share your great ideas with everyone in the comments below.