Last week we talked about cash flow issues that many service-based business face and where those issues often stem from. Today I’m going to address how to approach other cash flow issues that both service-based business and point-of-sale (POS) businesses face (i.e. retail stores, restaurants, etc).
SALES ≈ CASH
You might recall that for most service-based businesses, sales don’t equal cash. However, for POS-based businesses where you collect money up front, via either cash or credit, sales almost equal cash in most cases. Typically, the sales you generate will end up in your bank account one or two days later, in most cases. If this is the case, what could possibly be causing cash flow issues in your business? I'm getting there...
Not enough sales / Not selling enough
It’s true, your sales numbers might just not be cutting it. It could be because, at one time, you projected sales numbers, but your business isn’t actually hitting those numbers now. Or you may be discounting your offerings too heavily. The surefire way to test whether or not low sales are the problem is to build a sales breakeven analysis. More on that later. In the meantime, here are a few sales-to-costs KPIs (key performance indicators) you should be looking at on a regular basis:
- Sales per square foot of space
- Who for: Retail, restaurants, other POS-based businesses
- Helps answer: Are we generating enough sales for our location?
- Sales per employee
- Who for: Tech, marketing, agencies, other service-based businesses
- Helps answer: Are we overstaffed or understaffed? How effectively are we utilizing our people?
- Sales per customer/user
- Who for: Service- and POS-based businesses
- Helps answer: How much of what we offer are our customers using/buying?
Your prices are too low
A lot of business owners I talk to think their pricing is spot on, but without having done any service / product costing. How much does it actually cost your business to deliver each product / service? Direct costs are important here (see Mike Albert’s article on why), but indirect costs are just as important. There is no doubt that the market often plays a role in pricing, but it’s more important understand what your prices and actual costs are for YOUR business. Otherwise, let’s just be honest – you’re just guessing. And guessing can be very a costly thing. I'm having a few of my clients go through this exercise right now.
Keeping too much inventory on hand
If you sell any sort of physical product (e.g. apparel, food, etc), you may be ordering too much of it. How quickly do you sell each of your products? Do you know how much inventory you should have on hand? In April? How about in January? Is there seasonality in your business that affects your customers’ behavior? When? By how much? By not accounting for these types of factors or tracking this data, you are just guessing. And as I've said before, guessing can be very costly. I just looked at a P&L a few days ago of a business that should have had a 25% profit margin for the month. Instead it was 7%. Can you guess why? Too much inventory was ordered. How much? 250% too much.
Some of your products don’t sell well
Don’t keep offering services or ordering products that don’t sell well. Selling well could mean, higher margin, lower quantity sold or lower margin, higher quality sold. You need to be tracking the products that sell well vs the ones that don’t. Holding on to products that don’t sell well – whether it’s a marketing package (yes, that can be a product), a handbag, or a cocktail on your bar's drink menu – will only help negatively affect your company’s cash position. It’s likely that it probably won’t drain your cash balance immediately. The bigger problem is that it will do it very slowly and then one day you’ll realize you have a massive problem that could have been avoided if you had stopped guessing.
You don't know how long your capital will last
So you’re a tech startup and you raised $1 million in funding? Moving into a nice office building? Going to hire a bunch of new employees? Good for you. What level of sales are those investments going to help generate? What are your costs going to be? Having capital and access to capital can be important. But what’s more important is understanding how long that money is going to last. When will you be at the point when your business is profitable (you're generating enough sales to be self-sustaining) and largely doesn’t need to rely on raising additional funds? Because if you don’t know, you’re just guessing. Stop doing that. I promise your investors won't like that.
You haven’t built up a cash reserve
Many times when I ask the question to business owners, “Have you built up a cash reserve?” They respond with, “What’s a cash reserve?” I’ll answer it here.
A cash reserve is an emergency fund for your business. You can use it for different purposes:
- when sales fluctuate due to seasonality
- when customer payments slow down
- when you experience unexpected brief interruptions in business
- when you have a large, unexpected expense
- to pay partners’ quarterly distributions and taxes
- to reserve for accrued bonuses
Every business should have an emergency fund. You have one for personal finances. Why not for business? Work to build up your business’ cash reserve to at least three months of operating expenses.
Your Expenses Are Too High
You could be generating enough sales, but your expenses could be out of whack. Begin by comparing expenses to sales. Start with your largest expenses. Among them are probably payroll and employee benefits, cost of goods sold (if applicable), rent, repairs and maintenance, insurance, advertising, and general and admin costs. If your variable expenses are too high, no matter how hard you work to increase sales, you may still end up with an unhealthy cash position. I talked with the owner of steel company doing $1.3 million in sales with a 30% profit margin and had a cash balance equal to about 10% of sales. Twelve months later, his company's running cash balance was barely able to cover a month's worth of payroll expenses. After I reviewed the company's books (prepared by a CPA), I found that the financial statements weren't even accurate.
HERE'S HOW YOU FIX THIS (IN 1 STEP):
If you've got the bandwidth, hire an outsourced CFO who can help you not only with cash flow, but also profitability, business performance, financial statement accuracy, and several other things that will help you do business better. A knowledgeable CFO will save you more money than you are paying them.
HOW TO FIX THIS (IN 6 STEPS):
Step 1: Stop guessing.
Guessing can lead to major issues going unnoticed and staying unresolved. In the worst case scenario, you could go out of business. Think I'm being over-the-top? Over 80% of business fail due to poor cash flow management. Here's Jared Lecht, co-founder and CEO, reiterating the same statistic.
Step 2: Determine your sales break-even point.
I cannot stress how important it is for every business to understand what their sales breakeven point is. I will write a separate post on how to determine your sales break-even point because there are a lot of things involved in the process. If you know how, don't forget to add back non-cash items like depreciation and include non-P&L items like debt service payments.
Check benchmarks for your industry (e.g. generally, payroll for restaurants should not exceed 35% of sales, payroll for creative agencies should not exceed 55% of sales) and compare them with your company’s performance.
Step 3: Build a 6-week and 3-month cash flow analysis. Or use Float (way easier).
Your sales breakeven point isn't where it ends. You need to see when cash comes in (cash inflow) and out (cash outflow) of your business. Here you'll be able to identify if your cash position is healthy and specifically what you'll need to improve if it isn't.
Step 4: Determine what the specific problems are and find solutions.
Are sales too low? Take this information to your sales team and build a goal around successful performance. Or hire someone to help you with sales. (Remember, whether you like it or not, every business has a sales team. I’ll talk more about this in a later post.) Are purchases for resale too high? Do a product price-cost analysis to determine if you’re pricing accurately. Are payroll costs too high? Analyze payroll costs by department, determine where there are inefficiencies, and work with managers to restructure.
Step 5: Monitor, monitor, monitor.
Never stop monitoring your business’ performance and financial health. After a baby is born, would it ever be a good idea to stop monitoring its health? Your business is your baby, and you should be the overprotective parent.
Step 6: Learn, adjust & improve.
As a business owner, you shouldn’t ever feel like can stop learning, adjusting, and improving. Take in the information from your sales break-even point, from your cash flow analysis, from your weekly or monthly KPIs, test things, evaluate what's working and what isn't, so you can do business better.
You might be asking: Do I actually need to perform this sales break-even analysis and cash flow analysis to figure out why I’m having cash flow issues? The answer is: without a doubt. Need help with that? Start here.
So let’s get to it. Let’s do business better.
accountant / financial consultant