Jumping into your dream business is a great idea. You have made your sound business plan, checked your existing market, and provided an absolutely amazing product and/or service. But even with a promising business venture, why do business go bankrupt even with so many sales?
The answer lies in handling cash flow. And this is why you should focus on cash flow management to survive or sustain a thriving business.
Cash is King
Cash is the lifeblood of your business. Even with high-recorded sales (due to accounts receivable), if the turnover from receivables to cash is too slow compared to your due expenses, your business will surely feel the pain.
Ultimately, profitable businesses close down because of poor cash management. In running your small business, one should always think, “Cash is King”. If you are without the King’s favor, your hard work will surely go to naught.
Just One Emergency Away
Are you safe from emergencies against your business?
Let’s say a typhoon hit your area and you can’t operate for a few weeks. Or one of your biggest clients decided to stop buying from you. Or your best salesman suddenly decided to quit and build his own business, directly competing against you (!). You will never know what will happen.
How long can your cash buffer sustain your business? Heck, do you even have cash reserves to begin with? This is not a rare instance, especially in our tumultuous economy. The first step? Check how much cash your burning.
Estimating Your Net Burn Rate
This is called the net burn rate. Simply put, it’s just your total inflows minus your total outflows. You might be afraid. But you have to face your numbers. Because numbers don’t lie. And by accepting and measuring your financials, you can improve them.
Check your past income and expense records. How much have money have you been collecting from sales? List it down per client (if you have repeat ones). Afterward, check out your fixed expenses (salaries, utilities, rent, etc.) and variable day-to-day expenses.
For example, if you have 40,000 PHP in total sales a month and 30,000 PHP total expenses, you have a net burn rate of 10,000 PHP. So, you’re not actually burning, but earning.
But this does not end here. Be conservative in your estimates especially in your sales. Check the worst-case scenario. What if you suddenly lost your biggest client? How much will you be your burn rate? What if you collect nothing this month, what is your burn rate?
Computations can change if you incorporate the seasonality of your business. Sometimes, sales and expenses can shoot up if your product or service is in season. Compute this separately also.
Take note of these numbers because it will be handy ballpark figures when you determine your emergency funds thereafter.
How Much Money is Enough?
After getting the range of burn rate, check the worst-case scenario. If everything is positive (good for you!), use the one where you absolutely don’t have sales.
Multiply this amount to 3-6 months. This is the ideal cash reserve you should have. For example, your total worst-case burn rate is -20,000 PHP, then ideally you should have:
20,000 PHP x 6 = 120,000 PHP Cash Reserve
If you have a seasonal business, just add the burn rate for the seasonal month/s and use the normal burn rate for the other months.
For example, you still have -20,000 PHP burn rate but during one peak month, it shoots up to -50,000 PHP. Then your ideal cash reserve is:
20,000 PHP x 5 + 50,000 PHP = 150,000 PHP
This is just a simple computation. This amount may or may not be needed.
So better put the money in a High-Interest Bearing Account to earn money while being idle. In the Philippines, you can check out this listing some of the interest rates for savings accounts in the Philippines.
Improving Cash flow: Credit Checks Discounts on Early Payment
Now that you know your stats, you can now aim to improve it. There are numerous ways to tweak your business processes to incorporate a better net burn rate.
One way is to give out discounts to your clients. Some big clients pay after 30 days, 60 days, or 90 days especially if you’re in retail. Why not incentivize them a small discount when paying earlier?
Like you can set the terms 5% discount if on the spot cash, 2% discount after 30 days, 1% discount after 60 days. Because of the discount, they will more likely pay up earlier.
It’s good also to make a credit investigation for buyers who will order a big amount. At least, you did your due diligence. And hopefully, you get customers who can pay you on time.
Another way is to “factor” your receivables to banking institutions. Simply put, it’s like you’re selling your receivables to a bank for a fraction of the amount. Let’s say 80% of the total amount.
And then, if approved, you just have to inform the buyer that the bank will now be collecting the amount for you because you “factored” there receivable to them.
Although you get a lesser amount, at least you have the liquidity to purchase more inventory or use the cash for other purposes for the growth of your business. And you technically outsourced the “collection department” to the bank.
Credit Card Float and Line of Credit
When paying expenses, you can use your credit to charge the expenses. Why so? Because you can take advantage of the credit card float.
It’s like extending your due date effectively to 15-30 days. And some cards offer rewards such as percentage cash backs or points that can later be used for payments.
Some banks also offer a “line of credit” for certain types of businesses. Basically, it’s a preapproved loan that you can use anytime you need money. And most don’t even cost anything if you don’t use it. To boot, you can also renew it every year.
Utilize these tools, but be wary because this is not an excuse to spend the business money lavishly and not have emergency funds. Be a responsible business owner.
When’s the best time for all of this?
Well, only you can decide on this. But consider this famous adage: “the best time to obtain funds is when you don’t need them”.
Certainly, it will be hard to borrow money if you’re desperate for it. So, it would be better to make time to fix some of the tips above. It’s best to be prepared for the future of your business. Good luck!