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Sustainable cash flow strategies for service businesses

cash flow pig

Right at the top of the New Year’s resolutions list for many SMEs was to get cash flow under control in 2014. Are you on track?

For entrepreneurs and small business, now is the time to assess priorities for the year and strategise how to take your business to the next level. In planning for growth and expansion, cash flow strategies are often relegated to an ‘ongoing process’ rather than a focused discussion and strategy.

To ensure healthy business growth, implement a sustainable cash flow strategy now and plan ahead.

A recent New York Times blog noted that fast growth is the road to increased profits and enterprise value; but that without profits and positive cash flow, businesses can have difficulty surviving.

The resonance of the phrase ‘cash is king’ is felt the strongest when entrepreneurs are worried about payroll and bills, and the banks will not lend you money. This is where sustainable cash flow strategies can help entrepreneurs sleep better at night and keep the business strong in a challenging economy.

Aim for long-term financial stability

To build a financially stable business set finance and cash flow goals for the business.

Realistically assessing how and when you want to reach your long-term financial goal helps in a few ways, namely:

  • Avoids the pitfalls of reviewing cash flow from a short-term perspective.
  • Plans for cash flow around growth and expansion strategies.
  • Makes you think of your ability to earn money in the future.

Also, for people who allow purchases on credit, it helps in forecasting how much cash is coming into the business and, if it is sufficient to cover expenses and make a tidy profit.

Profit first and growth later

A financially sustainable business is one that can pay for itself without having to borrow a great deal (or not at all). Rather than borrowing, aim for increased profit and use retained profits to grow your business. It shouldn’t be the other way around – especially for start-ups.

Be mindful of over-diversification and expansion. As business grows, it is easy to be excited about lateral expansion. This is great and I do encourage growth, but ideally, it should never come at the expense of cutting profit margins. Businesses that do not work on this principle are likely to be the first hit during difficult financial times.

Another common challenge is ‘cash flow crunch’ that accompanies growth. Sales are high so how can the cash balance be down? This happens often in service businesses where the work is billed after completion but employees (and possibly extra support staff) are paid immediately. Clients then pay you much later – creating a cash flow nightmare.

Timing is everything

You have to know when money is coming in and when it goes out. More often than not, entrepreneurs get caught up in the service and management side of the business and relegate accounting to support staff. You should know your two to three month cash flow projections without having to look at sheets.

Just because a customer is supposed to pay in 30 days doesn’t mean they will. Every business needs a receivables management plan to ensure prompt payment. When creating your cash flow forecast estimate how much you will make and when you can expect to receive payment – expected and actual payment details.

Here’s a quick cash flow checklist for service businesses:

  1. Have clearly defined terms of trade on your quote that clients have signed and agreed to.
  1. Invoice regularly to assure a steady cash flow and follow up payments per agreed terms.  Call clients to confirm that the cheque is indeed in the mail or ask for a payment confirmation for electronic transfers.
  1. Prepare 12-month cash flow projections that you update regularly, even when you are not sure what income is coming in. Listing all your overheads will give you a minimum income target required to sustain your business. It also gives you an indication of when you are truly cash positive and can instigate business growth without putting too much strain on your cash flow.
  1. Most businesses live off the philosophy that “deposits from the new job will pay for expenses from the previous job”. This is OK when the business is young and growing but is detrimental in the longer term – especially in a tough economic climate.
  1. Don’t put all your eggs in one basket. Make sure your income comes from a number of sources. I’ve seen many small businesses relying on one major client and when the client has pulled out, they’ve had trouble keeping the business going.
  1. Know your profitability. Reconcile each job for profit or loss. This empowers you to know the profitability of each job and recognise what category jobs are most profitable for your business and which ones to avoid. This will also help avoid over-servicing.

Cash flow issues hit most businesses at some point in time. Preparation and forewarning will enable you to tackle the situation to shape your financial stability and sustainability. And, give you better sleep in 2014. Kaching!!