Get a lean cash flow mindset and save yourself a lot of stress.
Mention cash flow to business owners or entrepreneurs and their eyes glaze over -boring! However, once they experience a cash “crunch” then suddenly, their eyes become wide open.
Ignoring cash flow is simply perilous to your business.
The lack of cash flow is not only a major constraint on business growth, it is one of the top killers of businesses. Ignoring it won’t help-understanding and managing it will.
Understanding profit and cash
The concept of profit seems easy for many of us to grasp and yet it is only an estimation that appears in your profit and loss statement or job costing system. If you think it’s real, try buying a latte with it. You will quickly find out that the Barista is only interested in your cash flow and not your profitability!
Cash flow seems harder concept to grasp and yet it is based upon simple calculations that make it easy to predict.
Many owners don’t appreciate the relationship between their profit and cash flow and they place the emphasis on profitability. Often SME’s have little or no focus on improving their cash flow and their working capital increases unnecessarily. This often requires bigger overdrafts or shareholders tipping in more working capital. This is a very inefficient use of funds that could be used to fund growth.
Ignoring cash flow can lead to profitable businesses steadily increasing their overdraft just to operate and going broke.
Do not think that slow paying customers are to blame, as they are only one cause.
Growing a business generally requires extra cash and lack of cash inhibits growth. It is therefore important to understand the role cash flow plays in growth and not just focus on increasing sales and profitability.
Make Your Cash Flow Visible
Forecasting cash flow is actually formulaic and therefore relatively simple to forecast compared say to forecasting sales. It is, however, frequently not done at all.
Some business owners monitor their daily bank transactions and watch their balance but this is not really forecasting the future, just the imminent.
Understanding and measuring the key things that consume your cash is crucial to improving it.
Shorten Your Cash Cycle
Shorten your operations cash cycle as this reduces your working capital.
From the day you receive an order until the day you are paid for the goods or services you are providing finance to pay for overheads, materials, labour or storage etc. Manufacturing businesses are often very aware of this, as they must purchase materials, process the materials into “work in progress” and hold finished inventory ready for delivery.
The longer the cash cycle, the more cash (or working capital) is tied up in the business and therefore this reduces the available cash to spend on growth.
Productivity initiatives can focus on reducing the overall time and materials needed which reduces your working capital.
Services businesses often ignore the concept of “work in progress” as it is less obvious.
Do not ignore it because it is still there and just as important.
A lean cash mindset applies just as much to a service business and the rewards can be great. Seeing your service as a production process can help identify, measure and improve it.
Design a lean cash flow Business Model
Do not fall in the trap of simply repeating existing business models and avoid providing working capital if possible.
Think about alternative Business Model Designs that could reduce the working capital burden on your business.
Here’s 6 tips to adopt a lean cash flow mind set.
- Take the time to understand the relationship between profit and cash in your business and analyse what is tying your cash up.
- Start to measure your cash cycle and focus on it. Calculate it in days and dollars and this will incentivise you to reduce it.
- Get your cash flow into a forecast and use it every day.
- Think of your “production process” and how to reduce your cash cycle.
- Spend your working capital on growing and not funding your inefficiency or your slow paying customers.
- Review your Business Model Design to see how you can change your cash cycle.
Remember businesses with strong well managed cash flows are often very valuable.
If you would like to know more about how I can help with strategy, mentoring and improving business performance please email brendan@lindfieldpartners.com.au or call 0401018282