If you are considering starting a business, one key lesson you may have learned from this pandemic is the importance of cash flow.
Many businesses had their cash flow completely eliminated due to the pandemic. As a result, most of these businesses had to shut down in as little as 3 months, some in less than 3 months.
These businesses went out of business because they had no cash.
- They did not have the cash reserve to sustain operations for 3 months.
- They could not wait for the government relief programs which took a little bit of time to kick in.
- They could not obtain short-term financing to stay in business.
So, what’s the lesson for those considering starting a business?
Don’t start a business unless you have an additional source of cash flow to sustain your business for at least 6 to 12 months if your business is faced with hard times.
The famous multi-millionaire, Dan Lok in this video, introduces this concept of the wealth triangle. In the video he suggested a three-step method for generating wealth:
- Build a high-income skill that will generate over $120,000 in annual income;
- Operate a scalable business; and
- Invest in high-return investments that will earn at least 10% per annum.
He notes that starting a business is the hardest part. He cautions against starting a business before developing a high-income skill that can generate cash flow for you. As Dan notes in the video:
“A business takes a tremendous amount of effort to build. Don’t believe that you can start a business and make money within a few months. Be prepared to go a year, two years or three years before making a profit. The only way a business goes out of business is if it runs out of cash.”
I could not agree more with Dan.
Before you start a business, make sure you have a cash reserve that you can potentially use if needed to keep your doors open for business.
If you’re already in business, you will agree that cash is critical to keeping your doors open. As they often say,
Cash is King!
Several years ago when I started a business with my business partner, we faced a number of cash flow challenges as we did not pay close attention to these 5 key drivers of poor cash flow I discuss below.
“Never take your eyes off the cash flow because it’s the lifeblood of business.” — Sir Richard Branson
So, I want to share these 5 key insights I learned from my experience dealing with cash flow issues in my business very early on. I hope they will help you avoid running into cash flow issues as you run your business:
1. Low gross margin
Following a close analysis of our margins, we realized that the low margins on our sales were a critical contributor to a lack of sufficient cash flow in the business.
This was primarily due to the low fees we charged early on in the business. In our attempt to quickly acquire clients, we went low on fees and provided services similar to other providers. We essentially competed on price rather than on value.
We could not justify charging a higher fee due to the lack of differentiation in the market place. To address this concern, we now invest in ways to differentiate our services from the rest of the market. We are continually working on different ideas to change service delivery and add more value to our clients.
If you are able to offer more value to your clients, you can charge higher fees for the value you provide — value that clients cannot get from your competitors.
“Entrepreneurs believe that profit is what matters most in a new enterprise. But profit is secondary. Cash flow matters most.” — Peter Drucker
2. Slow-paying invoices
At some point in my business, this was a big concern as we had thousands of dollars in receivables that were 30 days, 60 days, and sometimes 90 days past due.
The impact on cash flow can be significant when invoices are not paid on time. For some understandable reasons, we were shy to ask our clients to pay.
Our clients are busy professionals and business owners, so most often they simply forget.
As business owners, it is our responsibility to remind clients to pay. To address this problem, we implemented a few things like:
- Requiring upfront payment of a certain percentage of the total fees prior to commencing the engagement;
- Invoicing more timely;
- Following up more frequently on unpaid invoices;
- Offering early payment discounts;
- Implementing monthly or quarterly recurring pre-authorized payments; and
- Automating the process to remind clients of unpaid invoices.
3. High overhead expenses
Every business will have overhead expenses that must be managed closely. The overhead expenses impacted our cash flows and we found it challenging to cut in this area.
What we did was to look for cheaper ways to pay for the key things we needed. For example, we cut our radio advertisement which was expensive, and spent a fraction of that money on running events and online marketing.
“The more a business owner knows about their cash flow, the more empowered they become.” — Nick Chandi
4. Bad debt
If you’re in a business like ours, you will likely deal with bad debt. While the impact on our cash flows is less for this issue compared to the others, we have had our share of bad debts.
These are clients who just don’t pay part or the entire invoice. Requiring upfront payment has minimized this and implementing a more robust client engagement process is something we are refining to help substantially reduce the likelihood of bad debt.
“If I had to run a company on three measures, those measures would be customer satisfaction, employee satisfaction, and cash flow.” — Jack Welch
5. Slow investment or capitalization of the business
A growing business requires capitalization to fuel that growth. You can capitalize one of two ways — reinvest your profits into the business or add debt to the business by borrowing.
In running our business, we’ve used both options but to a limited degree. Although our business has grown over the last couple of years, the growth has been slow, principally because we’ve not been aggressive in throwing more capital to fuel growth.
Growing a business is a double-edged sword. On the one hand, it can put significant pressure on your cash flow. On the other hand, if successfully implemented, it can add a lot of new cash flow streams to your business.
We’re now at a place in our business where we feel comfortable increasing the capitalization of the business a little bit more aggressively than we’ve done in the past.
We continue to minimize owners’ draw from the business so we can leave the capital to invest in growth.
“There is really only one way to address cash flow crunches, and it’s planning so you can prevent them in advance.” — Elaine Pofeldt
The key here is to have a long-term view of your business that will enable you to invest more in the capitalization of the business.
I hope you find a few points from this article to improve your business cash flow. In upcoming articles, I will look into other core areas of running your business.
Cash is king!
If you don’t want to go through the experience that many businesses went through during this pandemic, then you have to keep a close eye on your cash flow and ensure you have sufficient reserves either in the form of cash saved or available financing if you run into hard times.
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