November 09, 2016 | BY Joseph Hoffman
1. Don’t Confuse Profits With Cash
When booking profits on paper, be sure to have the cash in the bank. This may seem obvious, but a lot of business owners don’t make the distinction—to their detriment. For example, your business may get a big order, but you have to sink money into production to fill it. If the client pays you 90 to 120 days later, your cash flow can turn negative. According to Parsons, many small businesses that fail do so not because they are unprofitable, but because they run out of money. The reasons vary, from long payment cycles to inventory management to a lack of investment capital. Understanding the levers that impact your cash flow can help you get a handle on this important metric. Parsons recommends using one of the many free cash flow calculators available to analyze and forecast your cash flow, like this one on her company’s site.
2. Revamp Your Payment Terms
Many small-business owners are at the mercy of big clients, who may take 60 or 90 days (or more!) to pay them. “We give our clients free money for 60 days,” says Parsons. “No bank would do that!” Parsons advises small-business owners to get tough and put clear payment policies in place. Know your industry averages. If other companies in your field have 15-day payment terms, you should too. And it’s not enough to stamp “Net 30” on invoices. Parsons recommends adding a late fee for tardy payments. For service-oriented companies, she suggests requiring bigger up-front deposits to cover costs and collecting the balance upon delivery. Finally, she advised, don’t underprice. Make sure you are building in a healthy profit margin and that you account for your time, including time spent traveling and planning. “It’s okay to charge for what you’re worth,” she says.
3. Plan for the Future
Don’t wait until it’s too late. Make sure you have enough cash to manage your business and cover upcoming expenses. Parson says that, according to her conversations with bank lenders, when a small business approaches a bank for a loan, 90 percent of the time they are already in trouble. The time to go to the bank, she says, is when things are going well and you foresee a need for cash in the future. That advice goes for outside capital too, says Kramlich. Building relationships with funders takes time, whether it’s a bank loan or a venture investment, so business owners should be looking out six to 18 months.
4. Understand Your Funding Options
There are many types of financing, each with their own costs and benefits. So business owners must assess what kind of capital is right for them. Loans that are secured—that is, that are backed by collateral of some sort—are often the lowest cost. That includes SBA loans and mortgages. Other asset-backed loans, such as factoring or purchase order financing, advance funds based upon your accounts receivable. These types of money lenders may take a really hefty chunk of your receivables, in some cases up to 40 percent, says Kramlich. But the trade-off might be worth it for business owners who need cash quickly. Debt can be valuable, says Kramlich, but sometimes it’s not enough to fuel a growing company. In that case, entrepreneurs may want to consider equity. Equity, or selling shares in your company, can be a great source of long-term capital, she says. That includes investments from friends and family, crowdfunding, angel investors, accelerator programs and venture capitalists. But you will give up some ownership of your company. The outside ownership, or dilution, is typically lowest with friends and family, but increases with angel and venture investors. A hybrid option is to invest in convertible debt, an interest-bearing loan that converts to stock over time. But Kramlich warns entrepreneurs to read the fine print closely and make sure they understand the terms, including how much of their company they are giving up.
5. Use Your Cash Flow to Help Attract Investors
Reiterating the importance of managing your cash flow, Kramlich stresses that a history of positive cash flow can help in obtaining outside capital. “Anyone who is going to finance you is going to look at that,” she says. In general, she advises businesses to do as much as they can to organically fund their growth and generate cash flow before turning to outside capital.
6. Leave the Excuses Behind
Finally, stop making excuses and start getting a grasp on your cash flow. “I hear all the excuses,” says Parsons, “from ‘I don’t have time,’ to ‘Why should I forecast, it never comes true?’” The fact is, an investment in understanding your cash flow may be the smartest one you can make.
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