Growing Costs Money
Growth, of course, costs money and the key thing to understand in small business is that profit and cash don’t always correlate.
If a business is growing rapidly then more and more working capital is needed, so more and more cash is needed to fund the growth of the business.
During one of my workshops I exemplify a graph that shows an increase in sales and profit but a decrease in cash balance because I know it’s important to understand cash flow, as cash flow is vital to business growth. One of the best tools we use to help our clients get over this cash balance hurdle is a three-way cash flow forecast. This three-way cash flow forecast identifies the relationship between profit cash and sales and indicates the levels of overdraft needed. Once this model is in place, we then start using it for financial modeling.
As an example, one of our wholesale business clients, doubled their business over a one year period. Most wholesale businesses work on a fairly long cycle; goods can take anywhere between 2-3 months to come from overseas, and often a deposit or full payment for the goods is required before the goods make it to stock. The goods can then remain in stock for anywhere between 30, 60, 90 or 120 days. Due to this cycle importing or wholesaling businesses could be funding up to 6 months worth of working capital.
If you want to double your business, you’ve also got to double your working capital.
For our wholesale business client we developed a three-way cash flow forecast which determined their overdraft needed to be increased from $250,000 to $500,000, but at that point in time they weren’t able to get assistance from a bank, so a number of different strategies to grow their business and fund the growth were developed. We re-negotiated with suppliers, we came up with a few different strategies to improve the efficiency of how quickly money is collected and some of the low value customers were placed on a Cash On Delivery basis so cash was received earlier, to name a few.
Putting these strategies into place over 12 months saw the business go less into overdraft than the year before! They were nowhere near the $250,000 overdraft limit, yet we had doubled their sales by implementing those strategies. We actually created a positive cash flow in the business as a result.
Identify your cash flow problems
The key is to identify the cause of your cash flow problem, and then form some strategies on how you can improve the cash flow in your business… While borrowing money might be a quick fix, it likely won’t be the best fix and could be the cause of grief later on.
Don’t look for a quick fix, understand that growth costs money, understand your cash flow, and understand that the best way to fix your cash flow problems is to look at your rules and your processes. By developing better rules and better processes in your business, you will be able to really maximise your cash flow.