Cashflow – Part 2

Hopefully, you are now using and managing a cashflow.  Given Part 1 of this blog, my goal was to get you to at least think about tracking your money on a regular basis.  If all you did was make some wild guesses about your spending and track the actuals on the template I provided, you are miles ahead of where you where before you started using the cash flow.  My goal with Part 2 is to get into more detail about how you can manage cash and make better decisions with your cashflow.

Let me give some more examples of why a cashflow matters.  A friend of mine has been growing a consulting practice for some time.  Her practice is primarily herself.  Over the years she has done very well, and her income has grown.  Recently, she was telling me about how much money she had in her bank account.  I asked her what her cashflow looked like in six months.  She doesn’t have one, so she doesn’t know.  I told her that she hadn’t really accrued anything until she understood how her spending versus cash coming in looked in six months.  The problem is that current cash on hand can be deceptive.  Most of the cashflows I have reviewed or managed over the years turn out to be very lumpy.  Yearly or bi-yearly expenses often cause your current cash to dwindle faster than you think.  Given that you have lots of cash in the bank, you may decide to buy something you wanted or give yourself a raise.  Six months from now, however, you may be borrowing money to catch up.  Without a plan for how you are going to manage your money over the coming year, you are at a loss as to what the money in your bank account means.  You really need to project out expenses versus income to get an idea of what you can do with the money currently available to you.

Now, let’s assume you took my advice in part 1 and that you have a cashflow spreadsheet.  How do you get better about using it to your advantage.  The first thing to think about is prioritization.  What expenses do you have to pay no matter what?  What expenses are going to be very hard to pay if you delay paying them?  If your phone gets turned off, how does that affect your business?  What vendors will work with you, and what vendors are inflexible on payments?  For example, can you negotiate 45 or 60 day terms with some of your vendors in order to allow you more time to accrue revenue against those expenses?

Negotiating better terms can make a huge difference in your cash flow.  In one of my past businesses, I had to spend a lot of money in order to acquire product.  We were producing a printed product, and we would spend about $20,000 to print our product when we performed a run.  A print run of this size might last us anywhere from 2 to 4 months before we had to print more product.  Early on in this relationship, I negotiated 60 day terms with the company that printed my product.  This was critical, because it allowed me more time to accrue sales, and collect the money to pay these bills.  Since I knew my cashflow, I was able to pay off this vendor consistently.  That helped me build trust with them that I would pay when I said I would.  The 60 day terms also allowed me to make sure I had the cash to pay more urgent bills, like payroll, phone and utilities.

Personally, I have a few key rules.  I pay my employees as soon as cash comes in.  Without employees, a business can be very hard to operate.  Also, they are providing a service with likely no upside other than their salaries.  Delaying payment to them is putting them in a bad position.  Not paying them in a reasonable amount of time can also decrease productivity and moral.  Further, employees are often a large part of any businesses expenses.  Catching up on missed payroll can be very complicated.  Overall, it is good to prioritize payroll.

I also pay my subcontractors right away, especially when they are a large portion of my expenses for a customer.  For many of my contracts, subcontract expenses can be significant.  Delaying payment of subcontracts, especially when that requires you to pay subcontractors out of revenue from future customers, can put you in a place where you may never catch up.  When you create this situation, you may not even realize that you are borrowing from future revenue.  The more you do this, the more likely you are to be running negative on your profit.  It can be very important to pay subcontractors as soon as you get your clients payment, because you may never catch up otherwise.

Paying phone, utilities and other small bills on time can be very important as well.  These services can get cut off and really hurt your ability to continue your business.  In tough times, you may delay paying them for 15 or 20 days once or twice, but stretching it much further can cause complications.

When you pay your employees can be important, too.  Depending on how regular your income is, you may want to pay them monthly versus every week or every other week.  Again, this may allow you to accrue the money you need over the course of the month to pay them.

If you do get behind, or you anticipate being behind, it can be important to negotiate this up front.  For example, some of my businesses have had large patent cost in a given year.   The expenses accrued faster than I could pay them.  Patent cost are often a long ways away from bringing you revenue to balance them out.  They can also accrue very quickly.  In this case, I negotiated a 6 month “catch up” period.  During this period, I took the total I currently owed plus any future maintenance cost over six months and divided by six.  I put this monthly payment into the cashflow and I stuck to the payment plan.  This helped me catch up at a reasonable rate.

Cashflow can be very different from profit.  Sometimes a business may make a good profit, but it doesn’t throw off extra cash.  That could be because the business had to pay back loans or buy equipment.  In both of these cases, the cash you pay may not end up as an expense.  Instead it may end up as a liability or asset.  Another example could be that you, as an accrual business, have delayed payment on receivables for a major client.  I have had my business show strong profit or lose in a given year while showing practically break even cashflow.

If your business is throwing off cash, then move the money off of the cashflow.  You could do this by having a savings “expense”.  Every time you put money towards this expense, you can move it to a savings account.  This will allow you to keep your cashflow close to breakeven while accruing cash.  Exercising this practive in your cashflow will force you to make sharper clearer decisions about your expenses.  Having a cash flow that shows a large amount of money accumulating does not lead to good decision making.  It is human nature to get a little sloppy by not thinking through the impact of each expense.  I highly recommend moving money off the cashflow if you can.  It will force you to get good at managing your money, even when things are going great.

Your cashflow will allow you insight into how everything you pay effects your future cash.  It can also allow you to comfortably save money or pay out bonuses without the concern of how that will impact your future cash.  I highly recommend that any one running a business set up a cashflow.  Without it, you will find yourself time and again stressed about paying your bills.  With a cashflow, you will have the tools to breath a little easier, even in very tough times.  You will also gain a level of comfort and confidence in your decision making regarding who to pay and when.