What’s more important – Profit or Cash?
You can get by with a decent strategy and some hard work – but not without cash. Many ‘profitable’ businesses (according to the P&L statement) have run out of cash and come to a grinding halt.
And cash becomes even more critical as the business scales up. Growth sucks cash (usually).
Great companies chose to keep 3 to 10 times more cash reserves than their competitors according to Jim Collins. This allows them to weather storms and is why Bill Gates mandated that Microsoft keep a year’s worth of operating expenses in the bank.
Whilst this might be a pipe dream for many of us, the principle stands – so how do we manage to get to the point where we are able to hold some cash in reserve. Aiming for 2 months of operating expenses in cash in the bank is an excellent target.
In this bloginar
Cash Conversion Cycle
Most businesses will have some aspect of each of these elements.
Even service businesses have a form of inventory if they have underutilised staff. What might differ is the sequence and overlapping.
What is important is that during this cycle cash is basically tied up in your business. If you want to be able to scale then you are going to need to minimise the amount of time cash is tied up.
It’s a good idea to look at your cash daily – at the very least weekly! Either yourself or have someone report on it to you with a short explanation of why it changed. Cross check with your accounts receivable and payables also.
Growing business should set time aside each month – ideally in the monthly management meeting/ board meeting – to brainstorm ways to improve each of these components. Even if you are the only person in your business it is still worth doing the exercise.
Most of the ways you can make improvements fall into 3 general areas:
- Speed things up/ shorten cycle times
- Eliminate mistakes
- Change the business model
Here’s a one page tool based on Verne Harnish’s CASH tool in his book Scaling Up that you can use for this exercise.
Think through the steps that make up each of these elements for your business and brainstorm ways to improve them.
When you do this try to keep your mind open and not be trapped by “Can’t change that – it’s just the way things work in our market/ industry”. Ask questions like “What if…?”
Here’s some ideas to help get started:
- Ask! If you want to get paid sooner, ask. As a minimum send a statement as soon as you payment date passes. Think about friendly reminders before the due date.
- Don’t restrict yourself to invoicing once per month – and then give 30 days terms! Think about more frequent invoicing
- Do you have to offer 30 days terms? Think about shorter terms and give a ‘Due by Date’
- Can you encourage any form of pre-payment? Perhaps a deposit, perhaps stage payments? Is there something you can offer to give value back for those that pay upfront/ on time?
- Think about automated payments for recurring revenues – GoCardless is one option
- If customers are paying late – make efforts to understand why. There may be something simple you are not aware of that you could change to fit in with their needs
- Think about paying some expenses on a credit card. As long as you pay it off each month then it costs you nothing (usually) and means you keep the cash in your business for up to 30 days longer.
Don’t forget that improving margins will also improve your cash flow – so we also need to consider some key financial levers – there are 7 of them.
A focus on these combined with the cash strategies earlier will pay dividends in both short and longer term cash flow. And don’t think you necessarily need to make huge changes – a small percentage change in each will make a major change in profitability and cash when combined.
We often refer to this as the ‘Power of Small Change’ – Verne Harnish and the Gazelles call it ‘The Power of One’ referring to making 1% changes.
Mazda used this idea in their production processes where they challenge themselves on making a 1% improvement in each step – for example in their weight reduction programme for the new MX5 where every component of the car did this – and overall they saved in excess of 100kg on what was already a light car.
So the 7 financial levers are:
- Cost of Goods/ direct costs
- Operating expenses
- Accounts receivable
- Inventory/ work in progress
- Accounts Payable
Again building time to brainstorm these levers will yield some powerful results. Try to think beyond the obvious – for example price is not just about increasing your headline rate. It might be about upselling or bundling to increase your average order value.
If you back up the brainstorming by picking one cash improvement strategy as a quarterly/ 90 day focus then you will be well on the way to building a business with good cash flow management and capable of scaling.
It is one routine that will really set you free to grow – and you might sleep better also!
BizSmart aims to help business owners of small and medium sized businesses to create value and scale their businesses through sound practical business support by providing- Insight, Clarity and business support with a real determination to help you succeed. You can access blogs like this and more besides through our free SmartRoom service here