Poor cash flow management has rung the death knell for many small businesses over the years, making successful cash flow management a very important part of building a sustainable business. Like many business owners, 20 years ago when I was running my own business, I didn’t take my entrepreneurial leap because I was particularly excited about bookkeeping and accounting, but it became a big part of how I spent a lot of my time. In today’s economy, effectively managing cash flow post COVID-19 is more important than ever.
There are 5 business metrics that directly impact a businesses cash flow and every business owner needs to understand how they interact together. I’m convinced these five metrics are the cornerstone of a successful business and a critical part of managing cash flow post COVID-19. Some are more obvious than others, but they all work together to keep the lifeblood of any small business flowing.
Metric #1: Income
Every business owner understands the importance of a steady flow of income into a business. Probably the biggest challenge facing small businesses owners today is the drop in income they experienced during the shutdown caused by COVID-19. As a result, meticulous accounting of the income coming into the business is more important than ever. I tracked this number daily, weekly, monthly, quarterly, and annually so I could make assumptions about what to expect and forecast how we were doing.
Although forecasting in the middle of our current health and economic crisis has become a lot more difficult, it’s more important than ever to accurately track your income. Fortunately, it’s a pretty easy metric to track. What’s more, the next four metrics don’t mean anything without it.
NOTE: Your income is incredibly important to a potential lender. It’s one of the metrics they use to determine whether or not your business has the ability to service debt.
Metric #2: Expenses
Understanding your expenses tells you how much it costs for you to do business. If you’re unsure, your accountant can help you categorize your expenses. For example, some costs are related to how much it costs to produce your product or service, while other costs represent fixed costs like those associated with the place where you do business and the fixtures that make doing business possible. The difference between your costs and your income determine whether or not your business is profitable.
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In economic situations like this, managing expenses, even micro-managing expenses, is critically important. Normally, I would suggest measuring each expense against questions like, “Does this expense help me generate more ROI?” or “Does this expense add value to my business?” Today, I also think we should be asking, “Will this expense help me keep my doors open?” And, I would put that last one at the top of my list these days.
Obviously some business expenses are more critical than others and may require a little belt-tightening by everyone—including your employees. When I’ve had to navigate situations like this in the past, anything that could be considered a “nice-to-have” was eliminated from budgetary considerations. This is a time for only spending on those “must-haves” right now.
Because your primary goal here is to manage expenses to protect your cash flow, don’t forget to consider the role your vendors can play, they can play an important role in managing cash flow post COVID-19. None of your vendors want you to close your doors either, so now is the time to negotiate with them for better terms. Maybe it’s going from 30-day terms to 60-day terms. Maybe it’s establishing a just-in-time stocking arrangement with them so you are only tying up your cash flow on those items that you are selling right now and your vendor is stocking for you. Leverage your best relationships to extend your terms and protect the income you do have.
Metric #3: Accounts Receivable Aging
Don’t ignore this metric.
If you offer your customers credit terms to pay for the products or services they purchase, do they consistently pay ontime? For example, if you offer 30-day terms are they regularly taking 45 or 60 days to pay their invoices?
Every business is different, but I found after 45 days the hit to my cash flow caused me to start losing profits and after 65 days, my profits were completely gone. What’s more, I found that for every day over 40 days an invoice was late, it got that much harder to collect. This didn’t leave me many options, I either needed to raise my prices to cover the customers who didn’t pay on time, stop selling to those customers with payment terms, or cut them off completely.
None of those options were very attractive to me at the time.
I spent a lot of effort trying to ensure that my customers paid their invoices on time. I started regularly calling them at the 30-day mark, I offered discounts to those customers who paid early, and eventually those customers who refused to pay their invoices as agreed upon either went to a cash basis or I had to cut them off entirely.
Fortunately, most people, when I explained to them the impact late payments caused the health of my business, they appreciated what I was doing for them enough that they paid their invoices on time, but there were a few who were costing me to do business with them and I had to make the hard decision to discontinue working with them.
Metric #4: Accounts Payable Aging
If you vendors offer you discounts for paying early, and you take advantage of the opportunity, you can effectively reduce the costs of the goods or services you offer. I know of more than one small business that is able to save enough money this way the discount covers a big chunk of their payroll.
If you have a supplier that doesn’t want to extend their payment terms as discussed above, maybe they will offer you a discount for paying early—10 days, 20 days, etc. The discount to your invoice could make a lot of sense depending on your cash flow situation.
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Metric #5: Your Cash Flow Metric
This may be last on the list, but is an invaluable tool to help you effectively manage your cash flow. As your business earns income, that income becomes an asset among all your other business assets. Expenses become liabilities, included among all the other business liabilities. Your assets and your liabilities help you determine whether you are marching toward profitability or trudging toward extinction. Post COVID-19, get to be good friends with your cash flow metric.
You calculate your cash flow metric by dividing your assets and your liabilities. This is such an important metric, if you’re unsure about it, I suggest you talk to your accountant. The ideal for this metric is 2:1, or twice as many assets as you have liabilities. This can be a challenge for many new or smaller small businesses, but anything below 1:1 is telling you it is costing you more to do business than your making—even if you have money in the bank at the end of the month. If your metric is below 1:1, in the long term you won’t be able to sustain business operations.
Income, Expenses, Accounts Receivable Aging, and Accounts Payable Aging all feed into your cash flow metric. Understanding how they all interact will help you weather the coronavirus storm and come out safely on the other side. Even in the best of times it takes discipline, but it’s even more important now in uncertain times like these.