Today on the show talk about cashflow and why it can make or break your business.
What is covered in this episode:
- Why cashflow is like petrol in your car
- The problems that can be caused by not having a cashflow budget
- Why you can show a profit but have no cashflow in your business
- The importance of understanding your working cashflow cycle
- Ways to improve your cashflow and working captial cycles
- Why all types of business need to understand cashflow
- The difference between a normal budget and a cashflow budget
- Why the banks will ask for a cashflow budget when lending money
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G’day, g’day to you and welcome to the ‘Business Made Easy’ podcast, where we make business easy. Jason Skinner, your host here for another week and if you’re just joining me this week, thank you so much for finding me. I’m glad you’re here and if you’ve been following me and following the show, and enjoying the show and subscribe to the show – then thank you too, for all that you’ve been doing. And particularly those leaving reviews on iTunes and a few of you have been in contact with me to let me know about the show, by all means, please do that. It’s how the show’s going to grow and how I can keep bringing it to you each week. If you are getting value of the show, by all means please let me know over on iTunes by leaving an honest review.
We’ve got a great episode this week, we’ve been covering a little bit over the past few weeks on growth of business, or not so much, how to grow your business and also the importance of financial statements. Keeping track of that growth in your business and that was episode 12 where we talked about the five things of how you grow a business. And then I gave you the tools and the calculator there to work out how to grow your business.
But in episode 16, we spoke about the importance of profit and loss and financial statements. Which tell you how your business is going, in terms of, making money. Are you making money or losing money? And those sorts of things.
But this week, we are going to go one bit further into an area that I am extremely passionate about. And it’s probably one of the most important areas of your business and that is the area of cash flow. And whilst it’s one of the most important areas, it’s also one of the areas that 99% of people don’t look at properly. Or don’t understand how to look at it. It really is a relevant topic for you and your business and the health of your business and the longevity of your business.
And I’m going to talk about some examples, I like to always give a story. Whilst the facts are true, they are from case studies that I have helped people with. I do change the names to maintain that confidentiality. We’re going to talk about some fictitious people today, called Danny and June and I’ll go through that with you, a little bit later.
What do we mean when we’re talking about cash flow? And I’m going to give you an analogy because I think it helps you to understand exactly what we mean by cash flow. And the first thing is, to understand is that we’re talking about money in your bank. And I think we all agree that money is pretty important, because, well it’s really important because we’ve got to be able to pay our bills. And we want to eat and provide food, put food on the table, we’ve got to pay taxes, we’ve got to pay our rent, we’ve got to pay for our car registration and licensing.
There’s so many things that we have to put money to every single day of the week, and that’s cash, cash flow. Cash flow is the money coming into your bank account and going out of your bank account. And I’m sure you will agree that that’s super important. Here’s an analogy for you to think about it, in your business. And what I want you to do, is think about the size of your business being the size of your car. You’ve got your profit and loss statement, that we talked about back in episode 16 and you know now that your profit for the year is X dollars. Let’s call that the size, that equates to the size of your car. If we’ve got a little four cylinder car, we might just be starting out in business and we’re only just turning over a little bit of money. We’ve only just got a bit of traction going. We might only be making a smallish profit, at this particular point in time.
And we mightn’t have a lot of assets and equipment and things like that, or stock. We mightn’t have a lot of that stuff at the moment, because we’re just starting out. We might be a consulting business or, very smallish sort of car, let’s call that our ‘4 cylinder car’.
And then you might have a larger business, where you’ve got employees you’ve got to pay each week. And you’ve got lots of plant and equipment, machinery. You might have trucks or forklifts or stock that you’ve got to keep on the shelves. Let’s call that a larger car, that’s our ‘big F250’, that’s a big beast of a car with 12 cylinders and whatever, I’m not really good with mechanics, sorry. You get my drift though.
We’ve got our smallish car and we’ve got our large cars, and then we’ve got every other car between there. Well, as you know with a car, it takes petrol to get you from A to B. If we go and buy a brand new car, if we buy a car today and we jump into the driver’s seat at the dealers, where we bought the car from. Well, if it’s got no petrol in it, we’re not going to get out of the car yard, are we?
We need petrol in the tank, and the smaller the car, we don’t need as much petrol. But the bigger the car, we need a lot more petrol. And I want you to think of that as cash flow. Think of that, petrol that you put in your car as your cash flow. And the size of your business is your actual size of your car.
Cash flow, we need petrol to go places and cash flow is the same in your business. You can’t get too far down the road if you don’t pay your rent, if you don’t pay your staff, if you don’t buy your stock and pay your suppliers. You won’t get too far down the road. Not only that, if you don’t have good cash flow, you can’t pay your taxes, you can’t eat, there’s no food on the table. You can get the drift.
The cash flow is like the petrol in your car and what actually happens is, when we run out of cash flow, we need to go to the, or fuel for our car, we go to the gas station. And we get gas and we fill it up and we go again for however many kilometres. And in your business, it’s exactly the same. It’s how long, does it take to keep replenishing the cash flow in your business. That’s an important thing that we want to know. And that’s what we call our ‘working capital days’ and without getting too technical about that, what we’re talking about there is, if we get a dollar out of our bank account and we invest it into our business. We buy some stock, we pay our employees.
How long does it take for that cash, if you like, to get, what we’ve invested with that cash, to get sold to a customer. And then how long does it take for the customer to pay us and put that money back in our bank account with some profit? If we invest a dollar, then we want to be getting $1.50 back from our customer. But we want to be getting it back quite quickly. Because the longer it takes to get that money back in, we need more money to keep paying the bills and that’s where this cash flow comes into it. We need to analyse what we call our ‘working capital days’, how long does it take to get that money back in?
I’m going to take you through that today and I’m going to show you why it’s important, as I’ve just illustrated there, in terms of the fuel in your car. It does affect your business, because I’ve seen lots of businesses where they’re actually quote profitable. They actually make good profit but they don’t have any cash flow. They’re not structured correctly, and they’re not collecting their money from their customers fast enough. They might be carrying too much stock, they haven’t got the fuel in the tank and it’s too far to the next service station, to be able to get enough petrol to keep going forward.
Even though the car’s getting bigger and it needs more fuel, the business just isn’t generating enough, the petrol stations aren’t close enough to be keeping that business afloat. And then what happens then is, basically they can’t pay their bills and then suppliers stop paying and then the landlord gets angry. And then the tax man comes knocking and the IRS and it all just compounds and snowballs from there.
Really, really, I think you can see from there that it really is a major fundamental part of your business, that you really want to get right. Today, I’m going to teach you about that. I’m going to show you where it can go wrong and what to look for. And I’m also going to show you how to monitor and fix any cash flow problems, as well. And if you stick around at the end of the show, I will have some, I’ll go through some things that I’m going to announce for you that are going to help you with your cash flow. They’re free things but they’ll be things that you can take away and really learn, hang around for that at the end and I’ll give you those freebies, as well.
Let’s start with a case study though, and I want to talk about Danny and June. Now, Danny and June came and saw me because they had bought a business, and when they bought a business, they bought an established bricks and mortar business that actually required the selling of physical products. And these, what I’m going to tell you here applies whether you’re selling physical products or not, but in Danny and June’s case, they were selling physical products.
They had a premises, they bought a business, it had a lease with a premises. And they had physical product so they had to buy stock etcetera to keep running this business. And they took out a loan from the bank and the way the loan was structured, it was going to be repaid over 15 years, and it was going to be $2000 a month. They were going to pay down on this loan, now, of that $2000, some of it was interest that they were paying to the bank for the use of the money. And the other $1500 was actually to pay down the loan that the bank had given them. The bank said, “Look, we’re going to give you this money. We’re going to charge you interest each month. The repayments are $2000 but I want $1500 to be reducing down off that loan every month.”
And to top it off, the bank also gave Danny and June an overdraft or a credit line facility of $25,000 that they could use for emergency purposes. If they got down the track and they ran out of cash, for any reason, or couldn’t pay their bills for any reason. They had this $25,000 emergency line of credit slash overdraft that they could use in their business, as well.
Now, where it went wrong was, Danny and June didn’t do any cash flow planning around this at all. They had looked at the financial statements of the business and they had worked out that the business was making a profit each year. But what they didn’t do, is they didn’t sit down and work out a cash flow budget. And I’ll talk about what a cash flow budget is, shortly but they didn’t sit down and plan where the money was going to come into the business and when. And they didn’t plan where the money was going out and when.
They really just thought, “We’ll be right, it’s making profit. We’ll just pay the loan repayments.” And that’s really where they went wrong because they didn’t have an understanding of their working capital cycle. Now by the time they came to me, because what happened, they started trading, they bought some stock, they had to pay their suppliers for the stock. And the stock came in, then the stock sat on the shelf for a little while, so it didn’t sell straight away. Some of it did, but they weren’t really moving it that fast.
But the rent still needed paying, and when they did sell stock, they had to buy more stock. But they also weren’t collecting the cash from their customers, at the same time. So they were allowing their customers to pay them within 30 days or on terms, on credit terms. What they were effectively doing was buying the stock, paying for the stock and then waiting 30 days to get the money back in their bank account.
Now, you can understand that there’s a gap there. They need petrol in their tank, which is the cash flow and what they ended up doing was, and of course the loan repayments were due, they were $2000 a month. They ended up dipping in to the $25,000 emergency fund, because they didn’t have any other money to do it. And the business wasn’t generating enough cash flow to help keep up with the bills that were going out.
When they came to see me, they were going, “This is just not working. We’re making, we’re showing that we’re making a profit on our books. So when I do the financial statements, it does show that we are making a profit.” But as I explained to them, “You’re making a profit but the profit isn’t coming into the bank. The profit is actually out there in the marketplace, your customers are taking time to pay you, so there’s money out there owing to you from there. You’ve invested money in stock, so you’ve got stock sitting on your shelves, that you might be carrying too much stock. So you’ve got cash that’s actually invested in that stock and you might be paying your suppliers, at the time they invoice you. Straight away, so you’re not actually paying them on terms but you’re letting your customers pay you on terms.”
You can see there, that there’s this whole compounding problem. And to top that off, when you pay principal down on a loan, that has to come out of your cash flow. When you pay that loan down, that’s coming out of your profit. So if your business is not generating, as I said, their principal reduction was $1500, before the business even looks like having to pay them some money to live on, it has to generate at least $1500 of cash to be able to reduce that, out of profit, to reduce that loan down.
This is why a plan is so, so important. A cash flow plan and a cash flow plan is different to an actual budget, where you budget for a profit/loss. And again, I’ll explain that very shortly but what I did with Danny and June, is I sat down with them and I said, “Okay, Danny and June, let’s have a look at what’s going on there.” We worked out how many days from ordering their stock to paying for it, it took. And then we worked out once their stock arrives, how long does it sit on the shelf before it’s sold. And then once it’s sold, how long do we have to wait until we get our money back in our bank account.
It turned out, it was something like 60 days from the very first day that the money left the bank account till the day that the money came back into the bank account. And actually with some profit attached to it, so 60 days they were waiting, 60 days they’re paying rent, they’re paying all sorts of overheads. They’re trying to live, they’re paying loan repayments. 60 days is two months, so that’s two months worth of $1500 that they’ve had to pay to their bank, to pay off their loan.
It was no wonder they were dipping into their emergency reserve of $25,000 and now they were paying interest on that, as well. The cash flow cycle for them was really, really bad. We sat down and we worked out, worked out ways that we could. Firstly, we did a cash flow budget and we worked out exactly what the year would look like and when things were going to be tight, and when we were going to have extra cash. And we also worked out ways that we could improve their cash flow.
How could we have the stock sitting on our shelf for less time? Was there a way we could contact our suppliers and see whether or not they could deliver to us, just in time? Toyota were very big at this, they actually initiated this just in time ordering, so that they didn’t have working capital on cash flow sitting on the shelves, waiting to go onto cars. This is the same for Danny and June, how can we get our stock, just in time when we need it? How could we improve the customer payments? We actually, was it worth us offering an incentive for the customer to pay cash on delivery? Or do we, was there an opportunity to cancel account payments in total.
I mean, you pay for your groceries before you leave the store, surely we could explain to our customers that they needed to also pay. These are all things we worked through with Danny and June and then we also, as I say, worked out a cash flow budget and took them through that exercise, to see exactly where we were going to be needing more cash or where we had surplus cash and was there enough cash flow there to actually maintain and operate the business?
And doing so too, also helped Danny and June to work out exactly how much they could take out of the business to live on, as well. Because that’s an important thing, it’s a common question I get asked. “Hey, I just got this new business. How much can I pay myself or as a salary to live on?” Well, hang on, you’ve got to pay all these things first, so that’s important to work out a cash flow projection there.
Now, cash flow and cash flow statements and budgets, cash flow budgets, they apply whether or not you’re in an online business. Whether you’re a farmer, whether you’re a bricks and mortar type business. Whatever business you’re in, you really do need to have a good cash flow budget. And I’ll give you an example, with a farmer for instance, a farmer’s cash flow might only happen seasonally through a year. They might plant their crops in late winter, early spring and then the crops grow through summer and it mightn’t be, so they’ve had all that time they’ve been buying seed, buying fertilizer, running tractors and ploughs and paying staff etcetera. But there’s no money coming in because the crop hasn’t grown yet. They can’t sell, if a farmer hasn’t got a crop, he can’t sell it.
And then, all of a sudden, they’ll get a big rush of cash when it comes harvest time because all of a sudden the crop gets harvested and gets sold at the markets. And then the cash starts coming in, and they’re cash rich again. Now if they spent all that money, when they got the cash in, then they wouldn’t have the money then to carry them through to the next season.
You can see the importance of cash flow there, and again, keep thinking of that fuel in your car. If you’ve got excess fuel in your car and you just dump it out and let it evaporate, the time that you need it, instead of storing it, you could be doing yourself a disservice there.
And if you look at a manufacturing business, they buy raw materials. They might buy steel or sand or whatever it is that they’re making and nuts and bolts, and all sorts of things. You buy that, if you buy too much of it for the amount that you’re subsequently making and selling, then that’s just going to sit on the shelf and again, tie up in cash flow and put cash flow pressures on your business. And that’s why it all needs to be monitored.
Online businesses are the same, if you’ve got an online business and you buy 20,000 skateboards from Ali Baba and you go and house them at Amazon FDA. And it’s just sitting there on the shelf and you’re not selling them, that’s cash flow tied up in products on shelves and you’re paying advertising, you might be advertising on social media. You might be paying fees for freight to get, there’s a whole host of costs that go into it. It applies to online businesses, physical businesses, cash flow. You’ve heard the saying probable, “Cash is king” and it truly is king. Because without it, you’ve got an empty shell, you’ve got a car with no petrol in the tank and that’s the critical point to make there.
Understanding about cash flow and understanding why it’s important to your business, we don’t want to say, “Well,” you’re probably wondering what’s the best way to fix it then.” I mean, “How do I work out what my cash flow is in my business?” And the way we do it, there’s several ways. By far the easiest way for you, and best way, is to, the most practical way would be to do a cash flow budget. A cash flow budget is different to a normal budget, because a cash. A normal budget tends to just look at what’s my sales, what’s my projected budgeted sales and what is my, what are my expenses? And that gives you a profit and loss. So that’s a budgeted profit and loss.
But a cash flow budget is a bit different because it goes a bit further to say, “Okay, this is my profit and loss. These are the costs that I’ve got to pay for, but I also have to pay tax. And I also have to pay my loan repayments to the bank and I also have to pay for some new plant and equipment at some point in time. Or I might have to, I might want to take, you definitely need to take into consideration your drawings, your living that you’re taking out of the business as well.
Cash flow is looking at everything, all the cash coming into the business and the cash going out. And what we want to look at, at the end of the day is, what is the bank balance difference between the start of the year and the end of the year? And we want the end of the year to be a lot higher than what it was at the start of the year. And if your cash flow is right and you’ve taken all those other expenses, such as tax and loan repayments and paying your suppliers and collecting money from your customers, you’ve taken all of that into consideration. You should have more money in your bank account at the end of the year in your business than you do at the start of the year.
And I can, if you send me an email to [email protected] actually, well you can send me an email but I’ll also put a cash flow template up on the show notes, to help you as well.
The other thing is, you can also go to, there’s software available that bolts into your accounting programs. I think a lot of you might know, I use Xero, is my preferred accounting, online accounting software. I have a program that I can do an analysis of your cash flow for you, so if you need a hand working out your working capital days and those metrics that I was talking about, drop me an email to [email protected] and I’ll have a look at that for you and make sure we can work out your working capital cycles. And just see what’s going on in your business, as well. There is analytical software that does actually analyse your financial statements and report back what your cash flow’s doing.
Don’t underestimate the, just one point on this, don’t underestimate the importance of collecting your money sooner on your cash flow. One day, I’ve seen instances where two or three days just make a massive, massive difference to the bottom line of the money that’s in your bank account, at the end of the year. Where I said before with Danny and June, it was taking 60 days to get their money back in. If we can improve that by two or three days, that makes a massive difference in the bottom line of their bank account.
Don’t underestimate, don’t just go, “Oh, it’s only two days, it won’t matter. Won’t make a difference.” It certainly does make a difference and if you drop me a line, if you need a hand with that, I’ll certainly have a look at things for you to see what we can do to improve those collection cycles.
But the main thing is, is that you understand it and you understand why cash flow is so important and understand what your cash flow is doing in your business. Because it might be exactly why you are currently feeling like you’re doing all this work, you seem to be making profit but there’s nothing sitting in the bank account. And that’s one of the things that people say to me all the time, when they come in. If I say, “Oh look, you’re making a profit of, say $100,000.” They go, “Well I don’t have $100,000 in the bank. Where is it? There’s no way that can be right. I don’t, I’m not even, I’m hardly living.”
It’s important to understand where all that cash is going and where it’s leaking out of your business, and it does leak out, if you don’t keep an eye on it. Definitely do that, as I said, I’ll put some resources in the show notes as well. Because there’s plenty of work we can do around there. And I’ll also put some fact sheets there of ideas around improving your cash flow, how you can improve your cash flow as well. Because that’s, so I’ll put up plenty of tips over there and you can go over to those show notes. If you go to businessmadeeasypodcast.com/episode17 I’ll make sure that I’ve got plenty of resources over there, in the show notes to help you understand better your cash flow and what’s going on in your business.
As I say, if you want me to actually do some more, deeper analysis of your business, I can certainly look at it, with our software and do some modelling for you around ways you can improve that as well.
It might seem difficult to start with, getting your head around all that. I really hope I’ve explained it clearly and in a way that’s meaningful. But don’t underestimate the importance of it, cash flow in your business is king and you need to be, at the very least, doing a cash flow budget. And that’s the reason why banks always ask for it, when you go to borrow money too. The banks always ask you for a cash flow budget because they want to see that you can repay the loan that they’re going to give you. They want to see that your business is going to be good for the money that they’re lending you. That’s why they always ask for a cash flow budget not just a normal profit and loss budget.
Critical to get that right. And whilst it will seem difficult to start with, persevere with it and start getting a really good understanding of the cycles in your business with your cash and you will jump in front of that. And you will see that, I mean business is a moving target, it’s moving every day. Sales happen every day, customers come and go every day, you need to jump on it ASAP to, if you aren’t already, to make sure that you are doing that.
The other thing I’m going to do, and I just thought of this actually while I was putting this episode together, and I think it will be helpful because I do want to help you get a grasp of this. I’m going to put together a free educational training on how to do a cash flow statement. What I’ll do is I’ll do a YouTube tutorial and, with a worksheet and we might do a case study and work through it and I can show you then how to do that.
If that’s of interest to you, best to go over to the show notes and I’ll have a link over there called ‘Free tutorial signup.’ If you go over there and put your details in there, I’ll make sure I contact you as soon as I get that out. I’ll probably do that over the Christmas break and we can start the New Year with a fresh cash flow. Probably a good time to do it, going from January to December. If that’s of interest, I’ll put a link over in the show notes as well and I’ll contact you as soon as that’s free and we might jump on a webinar or I’ll do it as a tutorial. That way we can continue using it and help you out there.
In summary, cash flow, it’s critically important to your business. I hope you can see now, just how important it is and why. I hope those ideas that I’ve given you there, also help you because, as I say, it is an important area of the business.
That’s all I had today for you, if you haven’t already joined our Facebook group. Then by all means, jump over and do that. You can do that by clicking on, in Facebook and going to, and typing ‘Business Made Easy’ podcast group and I’d love to see you over there. It’s a free group, lots of people talking about various things in business. We can talk about cash flow over there as well, I’m in there regularly. The best way to do that is to go to, as I say, Facebook and in the search bar, type in there ‘Business Made Easy’ podcast group and it’ll come up there. But come and join me over there.
If you haven’t already, make sure you subscribe to the show on iTunes, if you’re finding this of value, so that you get the show each week. I put these out every Friday, they are free. They’re a free resource to help you in business because I’m passionate about business. And you can check out a whole heap of stuff over at the podcast website, as well, which is businessmadeeasypodcast.com.
Thank you for your time, I really appreciate you listening and I hope it’s been of benefit for you. I really love bringing you these tutorials because they are so important to your business and making sure you get a better business life and that’s what we’re all about. That’s it from me this week, I am going to, we’ve got a great episode actually coming up next week. I’ve got an interview, we’re going to be talking with a guy, I just love the work he does in website design and just does some amazing stuff and I won’t spoil it too much now. But join me next week for that episode, that’ll be episode 18.
But until next week, I’m going to hand you over to Mia now, she’s going to take us home and here’s to your success. All the best, bye.