Cash Flow Management
“The growth of the Internet will slow drastically, as the flaw in “Metcalfe’s law” — which states that the number of potential connections in a network is proportional to the square of the number of participants — becomes apparent: most people have nothing to say to each other! By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s.”
– Paul Krugman, 1998
I invite you to take a walk around your office tomorrow with fresh eyes. If you don’t work in an office, you surely know someone who can give you a quick tour of their place of work. It’s very important to do this if you are seriously thinking about starting your own venture, or improving your ventures cash flow situation. This is how we retrain the RAS.
Make note of the number of people who are surfing the Internet on a company-owned computer or making personal calls on a company phone. How often and how long do people hang out by the coffee station (paid by the company) or water cooler? Find out how many internal meetings the average employee has to attend each month. What happens if they don’t attend? How many layers of management are there? Check the book of Standard Operating procedures. How many are there? All of these things might seem necessary in a traditional business place, they have no place in your start-up.
After your tour of the facility, take a break outside for some fresh air to contemplate alone. Imagine someone rich just left you this company in their will. The profit, if any, the company makes will flow directly into your bank account and will be your only means of income for the foreseeable future. If it makes no profit, then all costs will come out of your wallet, starting right now.
Every expense.
Now, go back inside and imagine these are now your employees, this is your office space. You have to pay for them.
Knowing all expenses come out of your account, what changes would you make right then and there? How many of the staff do you think are indispensable now that you have to pay real cash of your own to keep them? Do you really need a personal assistant?
In the days when communication was done via lengthy letter writing, personal assistants were an essential part of the corporate structure. In these days of technological wizardry, you can do it all with a few clicks or texts.
How essential are all the people in the finance and human resources department? You can hire bookkeeping services for a fraction of the price.
How many offices are empty with the lights and computers still on. Temperature control blasting heat or A/C ? How does it make you feel now that the company costs are coming out of your bank account?
The power bill will have to be paid out of your pocket. That printer cartridge that you saw someone throw away, are you sure it is really empty? What will you now say to the employee who insists he prefers to read reports in hard copy instead of online?
Those people hanging out by the water cooler are costing you how much for their inactivity?
The Reality of Your Own Company
Now, think about the company you want to start or the one you currently have that is already bloated with unnecessary expenses. You cannot afford to carry anyone who is not totally committed to the cause. With what you know about your peers and the fraudulent expenses, the false sick days, the company cars used for personal travel, their constant griping. Would you trust any of them to work at your own company and NOT do those things?
You can’t waste cash on heating bills in a half empty office space or on the salary of a receptionist who spends half the day reading magazines or doom scrolling on social media. You can’t afford to have people who prefer to read a report in print format than online. You can’t pay to have people hang around going on about last night’s reality TV shows. All that is a drain on cash, pure and simple.
If it’s true that so many small businesses fail within a few years due to cash flow issues, then from the first day you start your company, you are entering a battle for survival. Every cent counts, if you truly believe you need to hire employees, then surround yourself with people who live by the same philosophy. Regardless, you need to structure your company in a way that eliminates all those frivolous costs.
Cash flow and cash are not the same thing
Financial accounting is not focused on cash flow. It’s focused on net income or profit. Over the long term, profit and cash flow are approximately the same, the crucial difference is timing.
As we already discussed, timing from when cash leaves and enters is critical, especially as you get a company up and running. For example, when you make a sale to a credit customer, you recognize that sale immediately on your income statement. That’s called accrual accounting and your system might automatically order a replacement product ready for the next sale. At that moment you are doubly invested at double the cost. In addition, you don’t get the money for the first sale immediately. On your cash budget and statement of cash flow, you don’t show that credit transaction until you actually receive payment. That could be a month away or more, possibly in instalments. How do you bridge the gap?
The gap between profit and cash flow in the early stages could be very large. If you have rapid growth in credit sales, profit could far exceed actual cash received. This sort of situation makes smaller companies very vulnerable to running out of cash, especially in the start-up phase in anticipation of demand. Be more like Ebenezer Scrooge and monitor every unnecessary expense. If it’s not essential for your company’s survival, it has no place in you business.
Cash Flow Management is Quite Simple:
- Borrow capital or establish a line of credit before you start-up even if you don’t think you need it… you will. Statistics don’t lie in business. At some point you can expect a tricky cash-flow issue. Credit lines buy you time to solve it.
- Do not hire anyone as a full-time employee until absolutely necessary and even then question if there is not a better way of getting the same thing done.
- Do all you can yourself for free. This means learning new things such as bookkeeping, computer fixes, mailing services, and travel arranging for which you probably had help in your regular job. At first it can be frustrating to have to pay attention to the administrative details, but very soon you will realize just how little skill is needed, and then you will catch yourself wondering what those employees in your prior company did all day long?
- Keep travel and meetings down to a minimum. Why spend the cash and time to fly to meet when you can achieve almost as much for free over the Internet? Do you really need to have regular in-person investor and board meetings? Challenge your decision to call a meeting. Are you doing it because you think there is a genuine opportunity to achieve something or are you doing it because it is traditional? Meetings cost money.
- Remain unpaid or on the minimum possible for as long as possible. Do not rely on revenue to fund your lifestyle. Your business is a seperate entity to your domestic life. This means you would be foolish to start a company without capital, savings, liquidated home equity, loans etc.
- Do not lease office space or equipment unless your product or service relies on it. If you think office space is essential, please second-guess yourself. If you still think so, please ask other people what they think. If the answer is still yes, please contact me!
- Offer customers incentives to pay early. Payment systems abound on the Internet and companies such a Shopify or Stripe make setting up payment systems a cinch. You can also offer payment plans, but use an online broker with the resources and legal skills required to chase debtors. I once offered simple payment plans without the back up of an online lender. Some purchasers got confused between payment plan and subscription plan and when they cancelled what they considered a subscription it was impossible to chase them for the debt.
- Negotiate longer-term payment contracts with vendors. Some may allow a payment-free period. When I started my first company, I found suppliers quite willing to work with me on this. They prefer a company stays in business, and there is a mutual benefit to working out a deal. Ninety days to pay is normal at the start. 30 days is really tight for a startup.
Amazon
When you get this right, the benefits will be obvious. Glen Reishman was catalog manager for Amazon.com Inc. in 1996. Looking back on his time in the early days he noted:
“He invited me to join Amazon.com Inc., which I did. But what I remember most was, after lunch, walking into his office in the Columbia Building, and seeing a rack of blue colored shirts, his trademark at the time, and the door-as-desk. I laughed. I looked at the threadbare carpet and spartan furnishings, and said, “Investors must love this.” He gave me his patented laugh.
When I joined the company, I saw the door-desks being built all the time. They hired people to build them. Jeff told the Seattle Times: “These desks serve as a symbol of frugality and a way of thinking. It’s very important at Amazon.com Inc. to make sure that we’re spending money on things that matter to customers,” said Bezos, 34. “There is a culture of self-reliance. (With the low-tech desks) . . . we can save a lot of money.”
Cash flow management is not something you only have to get right once, it’s a constant vigil. Every recession catches out poorly managed companies and big names fall just as often as the small businesses.
Think of your business as a living entity and cash as the blood that flows through its veins. If it stops flowing for any reason the company, like any living thing, will die.
Quickly.
Resources
Here is a teaching module on cash flow and profitability.
