“Cash rules everything around me…” – Old Hip Hop Proverb
Cash flow is every dollar going in or out of a company. It is the essence of how companies stay operational; the lifeblood.
Think of cash flow like the circulatory system. The blood flowing through your veins is money making its way through your company, the heart pumps blood throughout the body to keep it going. The heart is your customers and thusly sends blood to the extremities to help run the company–the body in this metaphor.
It’s all connected and every part depends on each other to do its job well (or at least adequately).
You have to take care of your body, eat right, exercise and sleep. Proper maintenance and consideration are important because if you eat too much red meat, lose too much blood, or take up smoking your heart will eventually start to have a more and more difficult time doing its job until it can’t anymore.
Companies need a healthy flow of cash throughout each functional part of delivering a product to customers from marketing to operations, to customer experience and beyond.
All of this may seem like a no-brainer, but there are essential concepts of cash flow management that are better grasped when taught. It’s acceptable to not know, but it’s not acceptable to not learn these basic principles as an entrepreneur or anyone responsible for budgeting and making business decisions at any size organization.
Now that you’ve had enough of being literarily scolded, here are five things you should know about cash flow management (Now Metaphor Free!):
1. What is Cash Flow Management?
Cash Flow management is tracking and regulating how much money flows in and out of your business. Cash flow is the amount of money and/or credit that flows in and out of the company via profits and losses. Cash flow can measure the success of a business.
To state it plainly, you always want more cash flowing in than flowing out.
2. Accounts Receivable vs Accounts Payable
Accounts receivable are what customers owe your company. You may have run into the situation where you or someone on your team has to track down customers and charge them for their outstanding balance. Receivables allow you to reliably collect and track revenue.
Accounts payable are what your company owes service providers or vendors. This is where the tables turn and your company may often want to extend the period of time it has to pay its outstanding invoices to avoid shortfalls.
Shortfalls are essentially owing more cash than your company has available to pay. Companies often have net term payment agreements that allow them to receive a service or good and pay for it at a later date.
Net Terms (Net-30 vs Net-60)
There are two common net term invoicing periods, net-30 and net-60. While they both have their advantages and disadvantages, they both offer companies the ability to redirect cash flow to business functions like advertising or other revenue-generating areas of the business, giving you the opportunity to increase revenue in the meantime.
The downside to net terms is that they’re a gamble if you’re dependent on the free cash flow because that may be symptomatic of deeper issues and this could likely exaggerate them.
Some suppliers also have late fees, so make sure your payments are on time. Another disadvantage is that if your company/business abruptly runs out of money you may damage the relationship that you have with your suppliers, which in turn, can hurt your business even further.
While being responsible when monitoring your cash flow is a given, Brex, a financial services company, is shaking things up and doing financing a little differently by offering an interest-free corporate credit card on net-60 terms, unlike most institutions that collect on 30-day intervals.
Solutions like this are developed specifically for e-commerce companies that need a little extra room to operate before sales start rolling in.
Know your numbers and make the decision that’s right for your company. We can’t offer financial advice, but this is just common sense.
One good indicator of having a healthy cash flow is beating your breakeven.
3. Calculate Your Breakeven
What’s your breakeven?
Breakeven is the point at which your company’s revenue equals its losses.
The standard method for calculating your breakeven is dividing your total fixed costs by your price per unit subtracted by your variable cost per unit (which is the amount of money that it costs to produce the item/service. This number can fluctuate depending on the volume of products and costs of materials, etc).
Find the total. That’s how many units you need to sell to reach your breakeven point.
Anything above your breakeven is profit. From there, anything you put in the bank is your reserves or your rainy day fund.
This money can be relied upon in cases where your company is experiencing some sort of trouble like a temporary market downfall, supplier price raise, etc. This allows you to focus on the cash flow instead of worrying about the shortfalls.
It is generally recommended to have enough money to last your business about 3-6 months. Reserves are often critical in periods of hardship.
4. Incentivize Sales
This is where you can get creative and galvanize your sales infrastructure while really connecting with your customers. It’s your opportunity to make it personal.
Offer your salespeople or your advertising manager bonuses for reaching and exceeding their goals or having the best performing ad; they don’t have to be monetary. Offer them a trip or an adventure to a local hotspot.
Build out a referral program for customers to benefit from introducing their network to your brand.
Reward loyalty by giving the return customers a little something extra.
There are a number of ways to grow your revenue by incentivizing your people and customers. Done correctly, this will increase cash flow and create new opportunities for future sales.
Always accurately track all cash flowing in and out of your business. I can’t stress this enough. Over or underestimating your shortfalls or breakeven could leave your business in poor standing.
Tracking cash flow the right way will leave you in a better position to understand how to better allocate your resources and even make predictions on future expenditures and earnings. Precision is key.
These are a few basic tenets of cash flow management. The bare minimum. Internalize them and make it a best practice to always consider these points when making spending decisions.
Keep learning and sharpening your knowledge of how to set your business up to succeed financially.