A profitable business runs out of money.
That sounds weird, doesn’t it?
Because you sold the work. You made a profit on it. Surely the money takes care of itself.
News flash. It doesn’t. Not now, not ever.
Because there’s a complication that the most up-to-date balance sheet and profit statement won’t tell you about. It has everything to do with the timing of money in versus money out.
I call this cash velocity. Every business has their own cash velocity. It all depends of their terms of sale, their invoicing practices, the industry they serve, and the boatloads of other factors that make each business the unique thing it is.
Suppose you complete a $5,000 job this month. It costs you $2,000 to deliver, leaving $3,000 before your other expenses. On paper, that looks fine. Happy days!
Then your customer takes 45 days to pay.
Meanwhile, the $2,000 you spent delivering the job is already gone. Subscriptions renew. Contractors paid. Insurance due. Buy materials for the next job. Tax is getting closer every day.
Your profitable job becomes a cash problem because timing in doesn’t equal timing out.
This is a financial lesson worth learning when you run a business: the amount of money matters, but so does the timing.
Start with the next few weeks
You don’t need accounting software, a finance department or a fancy spreadsheet to see what’s coming.
Open a new spreadsheet.
Write in how much cash you have today. Then list the money you expect to receive and when you hope to receive it. Underneath that, list the payments you know you have to make and when they’re due.
Look forward as far as you can.
For an operating business that could be a few months. If you only just started, that horizon will be much shorter. That’s fine. Extend it as you learn more.
No need to predict the future to perfection. You’re just trying to find the trouble spots while you still have choices.
If your spreadsheet says you’ll have everything covered and $8,000 in the bank six weeks from now, you can stop worrying about that particular six weeks.
If it says you’ll be $3,000 short, that’s your warning shot.
A warning gives you options
Six weeks before a cash shortage, you have options.
Start with money you’re already owed.
Check every unpaid invoice. Chase down the overdue ones. Make sure invoices for completed work have been sent. If customers usually take 30 days to pay, invoicing them a week late makes things worse.
Then look at money you’re about to spend.
Which payments are committed? Which purchases can wait? Are you paying for subscriptions you don’t use? Are you buying stock or materials earlier than you should? Is spending based on the business you hope to have rather than the business you have today?
No panic, and that’s the point. Because you have time to figure it out. You saw the shortage way ahead of time.
If it catches you three days before payroll, rent or a supplier payment, your choices are limited.
Payment terms matter a lot
Effective cash management happens before you make a sale.
Imagine you pay a supplier in 14 days, while your customer gets 30 days to pay you. You are financing the gap.
Yippee, says your customer. Free cash, what could go wrong?
Do enough work on those terms and growth makes the problem worse. Every new job consumes more of your working cash while you wait for customers to return it. This single factor can and does kill profitable businesses every day.
Look hard at how your business gets paid.
Can you ask for a deposit before starting work? Can you invoice with order instead of end of month? Can a multi-month project have progress payments? Do customers really need the payment terms you’re giving them?
You don’t have to make life difficult for good customers. You do need to understand what their payment terms cost your business.
Watch what actually happens
Your first cash forecast is wrong. It always is.
Learn from it.
If you expect a customer to pay on the 15th and they always pay end of month, don’t forecast the 15th. If an expense you thought was once-off appears every month, put it into the forecast. If sales are lower than you expected, use the real number, not the number you want.
Update the spreadsheet.
After a while, you’re doing more than recording money. You’re learning how cash moves through your business. You’re getting to figure out your unique cash velocity.
And once you see that, you can change it to make it work for you.
The cash shortage that kills your business is the one you discover too late. The manageable one is the one you see coming.
