Running a business without properly managing cash flow is like trying to paddle a boat without an oar. Even if you succeed, it will be an upstream battle that will eventually wear you out. Understanding how to optimize cash flow is vital for startups. If you cannot manage your cash flow within the first year, your business will likely not survive the second and subsequent years. Here are four tips that can help generate positive and continuous cash flow.
Identify your “cash cow” service or product
As a startup, you’re only in business once you begin generating sales which will convert as cash into your bank account. Too often entrepreneurs are very excited about the products or services they feel their customers need, rather than allowing their customers to reveal what they actually want through their buying trends. For example, a new local bakery might be ecstatic about the creative candy treats they make, but notice that their simple pound cake sells out every day, generating sales three times more than the candies. During your startup stage, when cash is critical your first three years, identify your “cash cow” and capitalize on improving its sales. Eventually as your bank account grows, business owners will have available money to market and promote the products/services that excites those most.
Make you “cash cow” profitable
In our article, “6 Reasons Your Business Has Poor Cash Flow”, we explained how your profits control your cash. The higher your profit, the more cash it generates for you. Profit is controlled by your pricing mechanism and your ability to control both your direct and indirect expenses. Your direct expenses (i.e. Cost of Goods Sold, COGS) are those immediate costs of production which include, but are not limited to, your direct labor, materials, and manufacturing supplies needed to produce the service or product. Indirect expenses are associated with those daily costs of doing business: office rent and utilities, office equipment, computer software, advertising and marketing, sales and administration payroll, etc. Although these costs are not associated with the actual creation of your product or service, they do contribute to your business as a whole and must be included into your pricing. For example, a company that creates and sells custom bicycles has the following annual income statement:
If this company continues this way, they will be out of business soon. To determine how this business Bicycle Co. lost $10,000 one must first consider how their custom bicycles were priced. Beginning entrepreneurs think, “If it cost me $60 to make one bicycle, I will sell the bicycles for $1,000 each to make a 40% profit! And if I sell 1,000 bicycles in a single year, that’s $40,000 in profit.” This owner forgot to factor indirect expenses into his pricing calculations by instead thinking, “I estimate my indirect costs for this year to be $50,000, and if I plan to sell 1,000 bicycles, that equates to $50 I must allocate to each bicycle. If my COGS are $60, my total expenses are $110 for each bicycle. I want a 40% profit so I must sell 1,000 of my bicycles for $184 each.”
Now that the owner of Bicycle Co. has priced their bicycles at $184 versus their original $100, their annual income statement shows as the following:
Bill quickly and set timely payment policies
A key tip for better cash flow management is controlling the timing of funds coming in and going out. To take away the guess work of when you will get paid for your product or service, the best practice is to bill as “due upon receipt”. Depending on the industry, it may be customary to extend credit to clients or purchasers (Net 30 or Net 60), but while this may be convenient for your customers, lengthening the timeframe for receiving payment can bring a financial strain to your business. Be mindful that your business must continue to meet its financial obligations (indirect expenses) and any delayed payments can have an adverse effect on growth and stability during your startup stage. The key to positive cash flow calls for rapid collection of invoices and timely payments.
Cut, paste, & repeat
Now that you have found your company’s “cash cow”, take this same strategy and repeat it. Identify the product/service your customers are consistently purchasing, make it profitable by pricing that product/service so that your direct and indirect expenses are covered, and collect payments sooner than later.
To learn more about optimizing your business strategy for positive cash flow and enhancing your startup’s growth, Contact Us to speak with one of our trusted advisors to get you started on the road to quantum growth.