Forget Predictions: Forecast Your Future
Why cash management is so important when selling your business
When it comes to operating a sellable business, mastering cash management is one of the most important tasks facing business owners.
If you haven’t entirely mastered cash flow management, you aren’t alone.
“One of the first questions that business owners ask is ‘why do I even need to care about my financials? Isn't that something that my accountant can do?’” said Raincatcher CEO Marla DiCarlo in a recent Raincatcher webinar on cash flow management.
“Yes, your accountant can and should do the transactional work,” said Marla. “However, as an owner, you also need to understand your financials and the main reason for that is you can't fix what you don't know.”
Why is Cash Management So Important?
So what exactly is cash flow management and why is it so important?
Cash flow management is the process of managing the timing of in flow of cash into your business (receivables) against the out flow of cash out of your business (payables).
Why is this important?
No matter how much you’ve invoiced, you need cash on hand to cover your current payables. You may be owed $100,000 in billables, but that committed cash can’t help you if payroll is due and you only have $25 in the bank.
It may sound obvious, but it’s a stumper for many business owners. In fact, says financial transaction company Intuit, the top reason most small businesses fail is cash flow crunch.”
Small Business Cash Flow Statistics
The same study also found:
U.S. small business owners are losing $43,394 annually by foregoing a project or sales due to issues created by insufficient cash flow.
More than half of U.S. (52%) small business owners’ companies have lost $10,000 or more by foregoing a project or sales specifically due to issues created by insufficient cash flow.
It should probably go without saying that businesses that pass up potential business are not the ones voted most likely to succeed when it comes to being considered by a potential buyer.
More Cash Flow Statistics
Also, says Intuit, for most of these businesses lack of money in the pipeline is not the largest issue. It’s that businesses haven’t carefully managed their funds to ensure that they are available when receivables fall behind.
One-third of businesses have been unable to pay vendors, loans, or even employees due to insufficient cash on hand.
Among those who have had cash flow issues, more than 2 in 5 (43%) of small business owners have frequently been at risk of not being able to pay their employees by payday.
One-third (33%) of U.S. small business owners estimate their company currently has more than $20,000 in outstanding receivables, and the average U.S. small business has $53,399 in outstanding receivables.
Nearly two-thirds (66%) of small business owners report that the time it takes the money to process after receiving a payment has the largest impact on their company’s cash flow, compared to not getting paid by customers or clients within the terms of the payment system (34%).
Nearly one-third of small businesses (31%) estimate it takes more than 30 days to get paid, by customers, clients, vendors, or banks. During this month of lag businesses still need to cover expenses including overhead and labor costs – thus creating cash flow woes.
These statistics back up what Marla told webinar viewers: “If you don't understand what your numbers are telling you, how can you be successful? How can you thrive?”
When you start thinking about selling our business, it is critical to focus on your profitability, as that is one of the first metrics potential buyers will investigate.
One way to boost your profitability is by increasing your cash flow, which starts with understanding and monitoring your profit margins. Yes, that’s margins, plural, as you should be monitoring your gross profit margin as well as your net profit margin.
Gross Profit Margin
To calculate your gross gross profit margin, take your sales minus your cost of goods. The amount remaining is the profit on the sale. Then divide that number by your sales, which then gives you your gross profit margin
Marla recommends diving into the reporting tools offered by Quickbooks or a similar accounting tool so you can look at your services and your products and set them up so you know how to increase cash flow.
When you’re trying to increase cash flow, especially in advance of a sale, you can look at the % of income by each service or product stated on the profit and loss statement to determine which service or product will give you the best cash flow.
In the video, Marla gives the example of two services. For one, home modification services, you may earn $250,000 but you only keep 16% of the revenue due to the higher cost of the goods.
But maybe you also offer home consulting services, where you may earn less, but you keep 71% of your revenue, with a 71% gross profit margin.
To increase your overall cash flow, you have two choices: Focus more on the product/service that offers a higher gross profit margin. Or find a way to increase prices or reduce the cost of goods on the services with the lower gross profit margin.
“I would rather work smarter and not harder and keep 71% of my revenue,” says Marla.
Watching the gross profit margin can also help business owners determine if they're pricing their services correctly. Then by setting up a gross profit margin target and monitoring your results each month, you have set yourself up to better manage your cash flow.
Net Profit Margin
The net profit margin is a strong indicator of a firm's overall success and it is calculated as follows:
First, calculate your net profit by deducting all company expenses from total revenue. Then you divide the net profit by total sales to get the net profit margin.
The result of the profit margin calculation is a percentage. For example, a 10% profit margin means that for each dollar of revenue the company earns, you will keep ten cents of profit after paying all your expenses.
Cash Flow Forecast
Neither the gross profit margin nor the net profit margin ratios give you a complete picture of everything that's going on in your business
Marla reminds business owners that margins are not reflective of cash flow which is the critical key to business success.
“You need to make sure cash keeps coming in,” says Marla.
Managing your company’s cash balances will maximize the availability of cash. For this, you’ll need to create a cash flow forecast.
Budgeting vs. Forecasting
It’s important not to confuse budgeting with forecasting.
Marla compares your budget to a roadmap, while your cash flow forecast is like your GPS.
“The cash flow forecast is going to say, ‘whoa, hold back. We have construction on this path, so we're gonna have to reroute you this way.’”
It’s important to look at your numbers and measure what actually took place against what you projected. Knowing what's happening on the route you're taking can help you make better business decisions. Or to complete the analogy to guide you in deciding if you need to take a different route.
Most cash flow forecasts are either created weekly or monthly. Some are created quarterly, but Marla doesn’t recommend that, especially during turbulent economies.
The first step in creating your cash flow forecast is knowing your cash cycles, which measure the time difference between the cash outlay and the inflow of cash. Here you will need to calculate the cash conversion on your sales inventory in your payables.
It’s easier than it sounds. A simple method, recommended by Marla, is running a report of your customer payments for the last three months. Include in the report the payment date and the invoice date so you can calculate the average number of days it took them to pay.
For example, if one client took 40 days to pay, the second took 30 days, the third took 50 days, and client number four took 23 days, you could add together 40 plus 30 days plus 50 days plus 23 days to get 143 days.
Then divide that by four invoices, which indicates that, on average, customers take about 36 days.
Tracking Inventory Cycles
Next, you’ll want to track inventory cycles.
Marla says she often sees business owners calculate their sales cycles but then forget to calculate the cycles of when they need to purchase the materials they need to build their products.
“You want to make sure that you're keeping some type of spreadsheet to track your inventory balances,” says Marla.
Find an Expert
There are many reports in QuickBooks that can run cash flow and forecasting estimations, and Marla also recommends working with your CPA or accountant or bookkeeper, or even your business coach as they will all have tips for you to maximize your cash flow
When you’re ready to start talking about selling your business, the professional business brokers at Raincatcher have advised hundreds of business owners, and many of them increase their profitability.
If you’re interested in preparing your business for sale, the staff at Raincatcher can work with you to close a sale at an attractive price.