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Starting and running your own business is not for the faint of heart. The fact is 33% of small businesses fail in their first two years and 50% after five years. The most significant source of failure for these businesses involves cash. Cash is key to long-term business success. In fact, it’s been seen that 90% of companies that manage their cash correctly are successful.
Cash flow is a bit of a foreign concept for many. Most business owners think about the business in terms of the expenses they need to keep their operations going and how to sell their products. However, knowing how the cash is moving and will move through their business is another matter. Many business owners did not get into business to stare at spreadsheets and reports all day (unless you’re like us – we love it). Instead of avoiding this critical part of your business, here are a few quick and easy ways to measure if you are on the right track.
A simple calculation of available cash divided by payables will give you a quick short-term health check for your business. It ensures that you have enough to cover what you owe. The lower the result, the more cash (or credit) you will need to cover your payments. Before you can prosper long-term, you must first be able to survive short-term.
Ideally, you want this number to be greater than one. If it is less, now is the time to evaluate your expenses and cut back. Running your operations in a ‘lean’ mode for a few months can help you quickly get your ratio above 1.
Are you paying more or receiving more? Obviously, you want to receive more, but depending on your business, there may be times of the year when this ratio could creep closer to one based on workflow. An occasional month or two with a ratio close to one can be manageable if you know and plan for it.
When it comes to this ratio, 1:1 or less is risky. You can only keep current on your bill payments if your clients pay on time. This ratio leaves you no room for extra expenses or those slow payers. 2:1 is a sign that your business is healthy. At 3:1, you can plan for growth or expansion or save up for a rainy day.
How many days could your business run if you had no cash received? Scary question, right? Many business owners do not consider this number when reviewing the company’s financial situation. Most business owners will tell you that they could only survive less than 30 days.
A healthy business will have enough for a few months (2-3). If you are fortunate enough to exceed those few months, that is great, but you may consider using the excess to reduce debt or grow your business.
The simple and easy way to tell that your business is healthy is if you have cash left over after paying all your expenses and bills. In Profit First, we teach that “if you can’t pay your bills, you can’t afford your bills.” It is good to monitor this number over time to ensure that it is stable and does not fluctuate significantly.
This indicator of health is also vital when planning for enhancements, campaigns or growth of your business.
The reality is companies can survive for years without being profitable. They often manage to operate on the goodwill of creditors and suppliers. But to survive long-term, you need to be profitable consistently.
If you find your business is constantly struggling to create and maintain profit, consider:
Seek ways to get paid quicker. Depending on your position, offering discounts on early payments or enforcing late charges could encourage on-time or early payments.
Cut your expenses. This does not have to be a long-term change, just an adjustment until you can realign the ratios and profitability.
Consolidate high-interest rate credit cards to a lower-interest loan or line of credit.
Increase sales. It is as simple as that. A few more sales can have a positive impact when they are profitable.
Need help improving your business health check? Let us be your co-pilot who guides you in navigating your way through the challenges and helps you reach your desired destination.