Article Summary: Every business needs a profit expert. Among other things, successfully managing cash flow is critical to building a profitable business. Here are six tips:
- Separate your business and personal expenses
- Treat your cash like the asset it really is and put it to work for your business
- Create and use a budget
- Re-invest in your business
- Leverage your cash
- Keep your monthly obligations under control
In this article we also talk about 13 other metrics you need to regularly watch and how that can help you become the profit expert in your business. Keep reading to learn more.
Every successful business has three critical business operations under control:
I think the first two business operations make a lot of sense (at least they did to me when I was a small business owner), but I don’t think the accounting part of a business is as appreciated by the average small business owner as it should be—at least I didn’t appreciate it as much as I should have. In fact, to steal the idea from one of my friends, Allen Bostrm—CPA and author of the book In the Black: Nine Principles to Make Your Business Profitable, he or she who understands what the accounting function of a business is telling them can become the all important profit expert.
When I started my small business, I don’t think I totally appreciated the importance of the accounting process. As a result, I don’t think I ever became the profit expert I needed to be. Since that time I’ve come to appreciate that although you don’t need to be an accountant or accounting expert to build a successful business, there is a lot of valuable information within the financial reports and the accounting process that will absolutely help you become a profit expert and build a more profitable business—if you understand what those financial reports are telling you. But, you need to dig a little deeper than the surface level of understanding a Profit and Loss Statement.
I’m convinced that every business needs a profit expert—but that doesn’t necessarily need to be the business owner (but in many small businesses that’s the logical choice). A good accountant (that you trust) or a bookkeeper could also fill that role. If that’s the route you choose, you need to elevate them beyond the transactional nature of the accounting function and engage with them in a more consultative way.
To quote my friend Allen, “Over the years, I have run into countless small business owners who think they are profitable, but who really don’t know. The owner of a window washing company proved to be a typical example of this. He asked me how his business could become more successful. He had clients, and work was plentiful, but he wasn’t making any money. I asked him how he was utilizing the information he periodically received from his Accountant. He said that he only received information once a year in his tax return. BINGO!”
If your annual visit with the tax man is the only time you visit with your accountant, you are missing out on a lot of opportunities to add profits to your business. It’s like driving a car blindfolded, because without an understanding of what’s going on within your business financially, you don’t know where you are, where you’ve been, and even where you’re going.
For example, if you’ve ever heard the term, “Cash is King,” it could be talking about the role your Cash Flow plays in profitability. In my business, I found that whenever a customer took beyond 45 days to pay their invoice, I started losing profits. Anything over 90 days was actually costing me to sell to that particular customer. In other words, I would have been better off not making that sale. Poor cash flow management has rung the death knell for many small businesses and is one of the places a profit expert should focus their efforts.
What’s more, you can still have cash in the bank and be bankrupt. You could have cash enough to meet your obligations this month, but not enough profits to do it next month. How you look at cash flow has to be more than a current, monthly calculation.
Dive into your cash flow ratio. Your current assets include any cash in the bank, your inventory, and your accounts receivable. When you compare the value of your assets with your liabilities (or Accounts Payable and the current part of any other long-term payment obligation, like a business loan or auto lease), the ideal would be to have twice as many assets as liabilities, or a 2:1 ratio. Although this is difficult for many businesses to attain, anything below a 1:1 ratio indicates that it’s costing you more money to do business than the income you’re generating.
Here are six tips the average profit expert might take to manage cash flow:
- Separate your business accounts from your personal accounts. Avoid the temptation to intermingle funds. Don’t use your business accounts for personal reasons.
- Manage your cash appropriately and treat it like an asset that should be working all the time to earn interest. Use the cash you need for business operations and put the rest where it can generate more in interest.
- Create and use a budget. Work with vendors to try to keep your cash account consistent throughout the year.
- Re-invest in your business. New businesses should plan on re-investing at least 50% of their profits back into the company to lesson the amount of capital from other, costlier, sources.
- Leverage your cash by negotiating favorable terms with your suppliers that better suit your business needs. Instead of 30-day terms, maybe 60- or 90-day terms could make more sense. Suppliers are often very willing to negotiate with their best customers.
- Don’t allow the number of monthly recurring bills and expected receivables each month to get out of control. Watch them like a hawk. This will help you identify potential cash flow problems earlier, rather than later.
Cash flow is one of the most important things a profit expert needs to watch, but there are a few other important metrics a cash flow expert should regularly pay attention to:
- What are the daily, weekly, and monthly sales totals?
- What are the current cash totals available?
- What are the accounts receivable and how old are they?
- What are the monthly payroll numbers?
- Which products are selling?
- Where does the profit come from?
- Is our inventory current or obsolete?
- What are the major expenses for the business? How much are they?
- What are the overhead expenses?
- How does the business compare to last year? Last month? Last quarter?
- What are the most important numbers you want to see on a daily, weekly, or monthly basis?
- What is working well in the business? What needs to be improved?
- How is our customer service working?
As a small business owner, I would usually try to wait until the end of the day to look at this type of information, which usually meant it got put off until later. I would have been much better served to have started my day in the books looking at these things to become a more skilled profit expert.
Granted, this might not be every small business owner’s cup of tea. If not, take the relationship you have with your accountant, bookkeeper, or CPA from a transactional relationship to a more consultative relationship. They can not only help you understand what these reports are telling you, they can help you create an action plan to make improvements where necessary and capture more profits where possible.
Every business needs a profit expert.