As the old saying goes, ‘revenue is vanity, profit is sanity, but cash is king.’ Getting cash flow right should be the north star of any business, but it’s unfortunately all too common for business owners to get blindsided by revenue at the expense of all else.
Over the last 20-plus years, I’ve had the pleasure of speaking with business owners big and small about how they manage the money side of their business. The one thing that never fails to amaze me is the lack of understanding of the importance of good business cash flow.
Worse still are the many business owners without a strong understanding of the financial position of their business, caught in what I like to call a ‘revenue race’, where actual profit is given a backseat to impressive-sounding revenue stats. You could have the most impressive revenue in the world, but if it’s all being eaten up by the business, you might as well start from zero.
So, if you’ve been living on a cash flow struggle street, here’s how you can begin to understand the financial position of your business better and prevent yourself from getting caught in a revenue race.
There is such a thing as bad revenue
Revenue is only part of the story of a successful business. Sure, you could argue that without revenue, there is no business. But there is such a thing as bad revenue.
I have witnessed small businesses chasing millions in corporate or government accounts, leaving themselves with a less than 10% margin to ensure they secure the revenue. Match this with long or late payment terms; these kinds of ‘big deals’ are a recipe for disaster.
Here’s what more businesses need to learn: it is more than okay to turn away revenue when it is not profitable for you. Revenue doesn’t always equal profit, especially if that revenue can only be achieved at great expense.
The 10% rule
If you have a new deal you are considering, the 10 per cent rule could help to ensure your business’s cash flow remains healthy, enabling you to invest back into the business and your staff easily.
First, make sure you are operating at the correct gross profit for the category you are in. Every small business needs to operate at a minimum of 10% net profit. So if you are a $2 million dollar business, you should have a net profit of $200K.
Bear in mind that after all COGS, COS, wages, loans and expenses go out, with 10% going back into the business. This should happen first before anything else.
Let’s say you have completed a new deal worth $100k, you have just received payment of $100k, and you know you have suppliers, lenders and staff to pay. The first payment is to your business, with $10k going straight into the business’s profits account. You should have a separate account set up for business profits. This should be the case with every single deal or invoice that gets paid. Even if it’s a $100 invoice, $10 must apply to the profit account.
The business profit account should get paid first, closely followed by payroll (including paying yourself), along with lenders and suppliers.
Since small businesses often neglect to factor in and allocate their profits, this ‘10%’ habit will ensure that your profits are turning into cash assets, which you can use to pay down a loan, invest in capital or even expand at the end of the year.
Try it out for a month, and you will be amazed at how quickly your profit account grows. If you find yourself falling short or extending a timeline for a loan or a supplier, you may need to adjust your pricing to ensure you are, at a minimum achieving 10% net profit.
Ultimately, the key to successful cash flow is to avoid getting starry-eyed about revenue without the profit to back it up. If you can’t save 10% into your profit account, it’s time to make some changes.