What Do You Mean By Cash Flow Clarity?
When you have cash flow clarity, you go from not knowing what’s happening to your cash flow to being completely aware of your cash position.
When you don’t have cash flow clarity, then you might have some of these questions in your head.
- How much cash flow is enough?
- Why might a profitable business have cash flow problems?
- When projecting future revenue and cash flow, how far into the future should my projections be deemed reasonable?
- What should I do when I have cash flow problems in my business?
- Is my cash flow healthy?
In This Section, I Will Help You Find The Answer To Each Of These Questions So That You Can Go From Cash Flow Confusion To Cash Flow Clarity.
Is Your Business In The Fast Lane Or Slow Lane?
A business owner drives a business like a driver drives a vehicle.
So, in which lane are you driving your business right now?
Slow Lane, Middle Lane, Or Fast Lane.
Why does it matter?
It matters because the vehicle’s speed matters when reaching the destination safely and enjoying the ride.
Maybe you are thinking you are driving in a slow lane,
And the question is, how do you know it is the right lane for your business right now?
Maybe you are in the SLOW lane, where you should have been either in the middle lane or fast lane, and your competitors are overtaking your vehicle enrolling your clients because you have been slow to react?
Perhaps you are in the middle lane when you should have been in the fast lane because your competitors are overtaking you and enrolling your clients.
Or maybe you should have been in the slow lane instead because your cash flow burn rate is so high that it cannot sustain business growth.
Maybe you are riding in the fast lane when you should have been driving in the middle or even the slow lane, and there’s an accident waiting to happen. What is an accident in business? It is a business failure.
Colin experienced a similar failure within six months of building a £4m business over five years when he was pressing on an accelerating pedal, i.e., spending money borrowed from the bank to generate more sales. If you haven’t read his story, here’s the link. (← there is no URL linking so leave this link in RED or a distinct color so we know that we need to add a URL here.)
Here’s the thing.
What if you thought you were driving in a particular lane, and that is not true?
E.g., what if you thought you were driving in the middle lane and you found out you were driving in the slow lane?
Such mistakes will lead to lost opportunities for your business because your competitor will overtake you and reach your clients first.
There’s a saying you might be familiar with:
“early Bird Catches The Worm.”
The worst part is not that you didn’t get a chance to serve the prospect because you were late in reaching out to them, but the competitor actually might not be as good as you are and, in fact, maybe doing low-quality work. So you are doing a disservice to the prospect by not reaching out to them sooner.
But what if you think you are going slow and you are going fast. There‘s potentially a major traffic accident waiting to happen.
In business, such a major accident is called a business collapse. A business collapses when the business is growing faster than the cash flow can support.
How does one know which lane you are driving and should be driving?
You find this out by having cash flow clarity in your business.
Why?
Cash flow is like an accelerator pedal. When you press on it ie. When you deploy cash flow in a business, the speed of the business vehicle increases.
With cash flow, you can hire an extra pair of hands, acquire an office or a store, or hire sales personnel. However, when you start deploying cash too fast before you know it, your cash burn rate, which is how quickly you are spending your cash, can go higher than the rate at which cash is coming into the business. In such a scenario, you’ll have a cash flow problem.
When you don’t have cash flow clarity, you don’t know what’s going on in your business.
“If you don’t know your maths in your business, you will lose because you don’t know what to focus on.” – Shishir Khadka
Cash flow clarity helps you identify cash flow gaps you are unaware of.
Cash flow clarity helps you avoid the fear of unknowns and losing money so that you are no longer stuck in analysis paralysis.
When you have cash flow clarity, you have a daily helicopter view of your business.
Cash flow is a more critical metric than profit when growing a business.
I have seen that an average entrepreneur thinks of profitability as a firm’s primary metric of concern. But operationally speaking, cash flow is a far more critical metric.
Cash flow measures the inflow and outflow of finances from a business. Companies need it to purchase the items they require to continue generating revenue. In addition, having cash flow available is necessary for paying taxes, salaries, suppliers, and utility costs.
Why Cash Flow Clarity Is Critical
Cash flow clarity is critical because clarity breeds focus.
Your business can fail without cash flow clarity, even if you are profitable overall. It doesn’t matter how much money you have waiting in your accounts receivable if you don’t have the cash you need right now to pay for the things your business needs. Without cash, operations will grind to a halt. Paying workers and suppliers will become impossible.
Unfortunately, novice entrepreneurs often focus solely on their profitability without planning their cash flow. Because of this, they can’t predict potential cash crunches. As a result, money balance problems creep up, and, many times, they only detect issues when it is too late.
Declining profits will eventually impact cash flow, but a lack of profitability is rarely the leading cause of a cash crunch. Instead, most businesses get into trouble when they tie up profits in hard assets that they can’t quickly liquidate. This makes it harder to liquidate funds when they need them.
Businesses won’t notice the material impact of a lack of profitability for several months.
However, if cash runs out, it will create disruption almost immediately.
Let’s go through some specific reasons why you need cash flow clarity.
Why You Need Cash Flow Clarity
To Know When The Time is Right To Expand
Expanding a business is expensive and often requires dipping into your cash reserves. You have to buy new premises, hire extra people, and market to a broader audience. Knowing your cash flow position is, therefore, vital. Growing companies can quickly burn through their cash reserves, causing them to grind to a halt, just when they need to strike.
However, you can prepare for all of this when you effectively manage your cash flow properly.
Having a week-by-week estimate of your cash position shows you how much money you are likely to have to hand in at any point in the future, regardless of your overall profitability. You can then use this information to determine whether you have sufficient funds available to expand or not.
To Protect Your Business Relationships
Cash flow clarity is also vital for helping you protect your business relationships.
If you are having cash flow problems, you may not be able to pay your suppliers, support companies, or utility providers. Failing to pay them can harm your relationship with them, damage your reputation, and even lead to price increases.
When you have a detailed cash flow schedule, you can see in advance how much money is going out and how much is coming in. You can then predict whether you will be able to take care of all your bills or not. If you can’t, then planning gives you time to adjust your current spending to have more funds available in the future.
To Find Out Where You Are Spending Money
Profit and loss statements provide you with a summary of your overall account position. They’re great for shareholder meetings, but they don’t tell you where you spend money.
A cash flow statement is different. It forces you to drill down into the details and precisely find out how money flows in and out of your organization. You need a line by line, item by item approach to developing robust estimates for how your cash flow position is likely to unfold. This exercise helps see where your brand could cut costs or find new opportunities in many cases.
To Improve Your Financial Strategy
Having cash flow clarity impacts your decision-making ability. It shows you precisely how much cash you have available now and how much you are likely to have over the coming weeks and months.
If you know that cash flow is going to be low, then you may be less inclined to make costly decisions (such as opening a new office) until your position improves. Likewise, if you have a lot of surplus cash available, that could be a sign that you are ready to invest in your business growth.
Now, you might be wondering, do I need to have cash flow clarity? Trust me, you do.
You will understand it better once you go through the stories of entrepreneurs who made cash flow mistakes because of a lack of clarity and the lessons they learned.
Cash Flow Stories Of Entrepreneurs Who Were In Your Shoes At One Point – Myths/mistakes And Lessons Learned
Alan’s Story – Doing Too Much, Too Soon
WHO HE IS
Meet Alan, who owns an online homeware eCommerce store. He wanted to expand his boutique online homeware eCommerce store to new markets to build revenue. The goal was to do as much as possible, all at once, to compete more effectively with rivals in the sector.
What Did He Do, And What Went Wrong?
He began investing heavily in marketing, eCommerce software platforms, and the brand’s website backend. After a couple of months, all the systems that the company needed were in place, but cash flow had taken a backseat. Alan soon realized that he didn’t have enough money to continue serving his regular customers, let alone provide goods to those shopping overseas.
What Was The Biggest Cash Mistake He Made, And What Was The Misconception He Had?
For entrepreneurs trying to bootstrap, such as Alan, the implications are clear: expand slowly and steadily. However, trying to do too much at once put the entire enterprise in jeopardy and forced the brand to take drastic action to protect its finances.
His biggest cash flow mistake was not having the proper cash flow structure to cover future cash outflows and not having a cash flow statement to guide him on what he could afford to do. He believed as long as his business is growing in revenue, his cash position will be okay.
Lessons Learned
Alan’s advice is to invest in the right place and save for the future. Only embark on a grand vision if you have the cash ready and waiting to make it happen. Running out of funds mid-project requires taking out expensive loans – something you’ll want to avoid. To do this, you need to prepare cash flow statements regularly, not just focusing on revenue.
If you want to go deeper, watch this video, on why cash flow is more important than revenue.
Carol’s Story – Leaving Tax Payments To The Last Minute
WHO SHE IS
Carol found this out the hard way. She ran a successful recruitment company that made good revenues in its first year. Customers loved the service and were keen to use the brand as much as possible to boost their business strategy.
What Did She Do, And What Went Wrong?
But while the product was good, the brand did not do enough to set money aside for taxes.
Instead, it collected all its revenues in a single account and used the money it received to pay its wages and expenses. Throughout the year, it kept dipping into this cash to purchase all the things it needed, pushing off the tax issue until the future. Unlike supplier invoices, taxes are non-negotiable. Companies must pay on time or risk fines and penalties.
What Was The Biggest Cash Mistake She Made, And What Was The Misconception She Had?
Eventually, tax day came around, and Carole didn’t have the funds she needed to make the payment. Colleagues used the regular business account for expenses, and now it was running extremely low on cash.
Lessons Learned
Whereas it is a typical cash flow mistake to forget about paying taxes on time, her biggest misconception was she believed it was her accountant’s job, not hers.
You can have all the inspiration in the world work on your money mindset, but if you don’t know your business numbers, you will most likely lose.
To avoid this, Carole changed how she approached cash flow. Carole learned that it was good practice to automatically deposit around 30 percent of all her revenue into a separate checking account to cover her taxes. This way, she could prevent people from using the funds to pay expenses, earmarking them to the authorities later on.
If you want to go deeper on this, watch this video on calculating cash flow as a coach or consultant. Although it is for a coach or consultant, the essence of coming up with a cash flow structure, strategy, and system is the same.
Dave – Failing To Manage Recurring Monthly Costs
Effectively managing monthly recurring costs is bread and butter for businesses. But entrepreneurs can only do it if they understand their cash flow position.
Who He Is
Dave is a blogging coach. He has a website that helps other bloggers rank better in search engines. In addition, he regularly gives speeches at industry events and is always looking to help others build their brands.
What Did He Do, And What Went Wrong?
But Dave had a problem – while his main business activities were a success, he was doing a poor job controlling small sundry monthly costs. He had multiple subscriptions and tools he was paying for, which individually cost peanuts but added up to a substantial amount.
What Was The Biggest Cash Mistake He Made, And What Was The Misconception He Had?
Unfortunately, he wasn’t tracking them how he should have been. So despite his twenty years of experience making money online, he was bleeding cash. He knew that he wouldn’t help his clients unless he could help himself first.
Lessons Learned
Dave turned the situation around by auditing his outgoing costs. He examined his monthly billings for data services, marketing tools, and spell checkers to see where he was going wrong. He soon realized that he was paying for many services that he wasn’t even using. Many he had forgotten he had ever taken out on subscription.
He later admitted that staying up to date on recurring costs was a great way to manage his finances better. When he finally got around to sorting through his outgoing cash flows, he saw that his business was much more profitable than he had thought.
Look, if you want to avoid cash flow problems because of a lack of cash flow clarity, just like Alan, Carole and Dave, I will share with you the top ten typical cash flow clarity mistakes entrepreneurs to make so that you can avoid these mistakes.
Top Ten Common Cash Flow Clarity Mistakes You Can Avoid
1. Not Leading With Your Profitable Products
It’s not unusual to find busy entrepreneurs who work hard every day and don’t have much to show for it at the end of the month.
Such entrepreneurs make big mistakes of not knowing or not pushing their most profitable products. This ignorance is due to a lack of cash flow clarity and not knowing which product or products are generating more cash flow.
See, it’s no good if you go out there, work long hours and put all this energy into your business without any significant return.
You can change it by focusing on your profitable products and dropping those that get you revenue but no profits.
2. Running Business Based on Bank Balance Without a Cash Flow Plan
Many entrepreneurs make crucial financial decisions based on their bank balance. If you are one of them, stop doing that.
It’s like driving a car and only concentrating on what’s ahead of you rather than looking around and also scanning the traffic on both your sides.
Driving like this, you can crash your car. Such an approach in business can hit the business.
The only way to avoid it is to have a cash flow plan, use it to understand your cash position holistically, and then make the financial decisions.
When you have cash flow clarity, you will know your accurate cash position, which includes planned and predicted transactions, which will not be reflected in the current bank balance.
3. Spending Money You Don’t Have
Emotions are a powerful force.
They can help you sell stuff.
But they also get people to buy stuff they don’t need with money they don’t have, i.e., the borrowed money.
Before you make purchases in your business, ask yourself, “Will this purchase help me grow my business, or is it an investment in my growth?” If the answer is yes, then invest.
If not, think twice before you spend your cash.
Remember, cash is the energy fuel in the business, so use it wisely.
Don’t get excited by looking at the social feed of ‘apparently’ successful business owners who you think are ahead of you?
Wear the logical hat and stop buying based on emotions.
When you don’t have cash flow clarity, it’s easy to make emotional decisions because you don’t know whether you can afford to buy or not.
Having cash flow clarity keeps you financially disciplined, not to spend when you can’t afford to buy.
4. Fear of Failure
IMAGINE, you are driving on a three-lane motorway:
AND you are on one of the three lanes:
You are in the slowest lane.
The reason why you are on this lane may vary.
Maybe it is the right lane and speed for you. Perhaps you don’t know which lane you should be driving in. You may also be driving slow because of fear. You want to go faster as you see others overtaking you. You feel hopeless.
People also go slow in business because of fear. As a result, you see others going fast, bypassing you amassing a vast client base while you struggle to keep your small client base happy.
This happens even when you know that you can service clients better than them. But it doesn’t matter. They are more visible and credible in the prospects’ eyes because they don’t fear failure and go fast.
So, having cash flow clarity is how to avoid the fear of failure to ensure you are driving your business forward at the right speed.
5. Lack of Financial Know-How
Many entrepreneurs think they could have managed the financial side of their business well if only they had an MBA or an accounting or finance degree.
And, because they don’t have those degrees or an MBA, they keep running from numbers in their business.
Good financial know-how in business means more than knowing how much tax you need to pay.
Financial know-how gives you clarity and confidence about where you are right now in your business in terms of sales, profit, and cash position.
And, if you are not where you want to be, financial know-how tells you what to do about it to get to where you want to be by developing a financial growth strategy.
Many entrepreneurs talk about business strategy. I believe it’s pointless without having a financial strategy in place. Without financial competence, you will not be able to develop a financial strategy. Because you need cash to run the business and implement your business strategy. So successful implementation of your business strategy needs financial know-how.
If you think your financial know-how is not up to the mark, then invest time and resources in developing it. It will pay you dividends in the future. Work with a coach or an established expert if you have to for this.
I believe the ability to grow your business in a profitable and sustainable way requires financial know-how, otherwise, you are just leaving your success to chance, which rarely works out.
Understanding financial knowledge leads to financial insights, which then leads to having cash flow clarity in your business/
6. Thinking It’s OK to Spend Because There Is Money in the Bank Account
No. It’s not.
Even when many women entrepreneurs make major spending decisions based on how much money is in their bank account. They tend to forget that a business collects tax on behalf of the Government. So, some of the money in their bank account is not theirs.
That is why it is important to have a clear understanding of your true financial position. Without this understanding, it’s easy to make bad business decisions that can send your business on a downward spiral.
Cash flow clarity gives you a true financial position.
7. Not Getting Professional Help on Time
You can avoid most cash flow mistakes just by working with a professional.
This is such a simple thing to do but many women entrepreneurs don’t do it. A professional or a coach can guide you on how to look through your numbers and build an understanding of the health of the business.
There will always be things that you possibly don’t know and can’t see. By the way, these two things are the biggest killers in the business.
Have you ever come across a situation, “Oh I didn’t know and I have been losing money as a result of that ignorance, or how about, I didn’t know I could do that and make more money without making more sales?
A good coach works with you as a front seat co-passenger or as a co-pilot guiding you through the rough bumpy rides in terms of lack of cash flow or leveraging your existing cash flow so that you can survive when times are tough and thrive when times are good.
Imagine going from wearing foggy eyeglasses to having a clear sight in front of you. This is possible to have instant cash flow clarity when you work with a cash flow coach.
8. Investing in other businesses, believing future cash will cover both businesses
When the existing business is doing well. There’s a temptation to re-invest the cash generated from the existing business into another business. There is nothing wrong with this. In fact, this is what you should do, but only when you have cash flow clarity.
You don’t want to be in a situation where the new venture does not generate enough cash flow to support itself and there are not enough funds in the existing business to support both businesses.
In order to find out whether you can invest in other businesses or not, you need to have cash flow clarity on whether your cash flow can cover bills to pay in the existing business as well as the new business if the new ventures fail.
Mistake 9 | Not Keeping an Eye on Cash Flow at All Times
When you don’t keep an eye on cash flow, you may end up with insufficient cash flow. And if in such times a crisis strikes, you will have to start looking at external funding which is hard to come by in tough times.
Even when you get external funding, it will come with high-interest rates and this is not the cash flow situation where you want to be.
If you have cash flow clarity, then you will be able to avoid such mistakes.
Mistake 10 | Not Tracking Your Marketing Spend Properly
Marketing is one of the biggest expenditures for growth-oriented companies. Even then we don’t take time to understand which marketing channels are performing well for your business. So you need to have cash flow clarity on which channels, campaigns are generating more cash and which ones are bleeding cash.
This is super important to know because you want to deploy your resources in places that give you good returns and use that to grow your business. Without it, you may be stuck where you are for a long time.
Now you know about the most common cash flow clarity mistakes entrepreneurs make. Let’s go a level deeper and see why they make these mistakes.
Through my work as a profit and cash flow coach, I discovered that the biggest reason why they make these cash flow mistakes are because of 5 myths or misconceptions they have about cash flow.
Here they are.
Myths Or Misconceptions Behind The Cash Flow Mistakes
Myth 1 | I Just Need to Make More, Sell More and I Will Be Okay
This is what a client told me, “Shishir, I just need to get more clients and make more sales and I will be okay.”
There’s no point in doing, doing, and at the end of the day, having nothing to show for it. Because business is more about keeping money rather than making money. Obviously, you can only keep money when you have made it first.
I have found that most entrepreneurs do not clearly know what happens between when money comes into their business and when it finally lands in their bank account.
They think that if the money has come in business, then some of it will get into their personal bank account.
It does not work like that.
It is not uncommon for entrepreneurs to work hard and serve the customers well, at the month-end, without much cash for themselves.
So, don’t get hung up on top-line revenue. It doesn’t mean anything if you are potentially struggling to pay your staff, tax, and even yourself.
Myth 2 | Money Is the By-Product of What I Do
During my interviews with female entrepreneurs, one of the questions I asked them was: “What does money mean to you?”
Some said it gave them freedom, a choice, or a tool to have financial independence
Others said it was a necessity and it helped them provide better for their son, daughter, or family.
There were also those who said that money was a by-product of what they did and did not focus on the money side of the business. That they wanted to focus on serving their clients better, making a positive impact. Because when they did that money came as a byproduct.
All of them have great answers and reasons and show good intentions.
Business can be a vehicle to pursue your dreams, achieve freedom, support those you love, and make an impact but it can only happen if you remain in the business long enough.
You ensure the longevity of your business by ensuring you have healthy cash flow. Remember 82% of businesses fail due to poor management of cash flow. PERIOD.
You can have a massive social media presence, make fantastic sales and profit and still yet go out of business, because of cash flow problems.
So pay attention to cash flow in your business.
I believe business is a long-term game like a marathon. It requires stamina as well as the skill to win. Cash flow or money is the stamina that keeps you going in business.
So I believe it is not the by-product of what you do. It’s a tool/resource, and energy for you to invest in the causes you care about, to make the biggest impact. So instead, improve the relationship with the money aspect of the business and your cash flow will improve in your business.
Myth 3 | No One Taught Me How to Manage Money so I Don’t Know to Do That.
You learn either by education or experience or both. . You have to have at least one of them.
We didn’t learn how to walk before we were born.
How many times have we tried to stand on our own two feet, let alone be able to walk?
It’s a process.
So when you say, I was not taught how to manage money, it means you never tried to learn to manage money. In the 21st century, there is no excuse for not learning whatever you want to learn because some of the world’s best learning is just a click away.
And, you can’t expect to become an expert just by blinking your eyes. We don’t become financially savvy entrepreneurs overnight. You have to take baby steps first before you can walk or run. It’s a process.
Mark Cuban said in one of his interviews, “If you’re going to have and run a business if you don’t understand accounting you’re already behind.”
This interviewer asked him, “Do you think you need college to learn that?”
He replied, “If you’re so self-motivated that you can take an online course in accounting and teach yourself everything you’re way ahead of the game.”
Even after 17 years of helping entrepreneurs with the money side of the business, I like to call myself a passionate student of the subject rather than an expert, who is always willing to learn, try new things, learn from mistakes, put my blood/sweat/tears everything into it and become a better financially savvy entrepreneur.
How about you?
Myth 4 | Numbers in the Business Don’t Matter Much, Because They Are a Result of What Happened in My Business.
I was talking to one of my friends, a savvy digital marketer and he said to me, “Shishir, how does going through the numbers help me in my business? Isn’t this a reactionary task?”
Here’s the thing.
Numbers do not form in a vacuum. They are a result of your decisions, which turn into actions and actions turn into numbers.
Numbers tell a story. Numbers tell how good or bad were the decisions you made in the first place.
So, if you want to improve your decision-making process, you need to be on top of the numbers. Because if your numbers signal that a particular decision or a choice was not good for business, you can choose differently.
Remember,
Metrics matter.
AND
Financial Data Drives Decisions in business.
Myth 5 | It’s My Accountant’s Job, Not Mine
I hear so many female entrepreneurs say, “Shishir, I don’t look at the money side of the business. I ask my accountant what to do and then I do it.”
It is as if your babysitter is deciding what is in the best interest of your child.
If you won’t do it for your child, why would you do it for your money?
I believe you can get help, and outsource the task of managing money, but you cannot outsource the responsibility of managing money, because it’s your money.
You can have all the inspiration in the world, work on your money mindset, but if you don’t know numbers in your business, most likely you will lose.
Instead of using an accountant, financial coach to help you on the financial side of the business, how about they become just an extra pair of eyes who are looking over your shoulder as a co-passenger rather than a back seat passenger and you are driving your money side of the business forward.
Tweet if you agree and tag me on social media.
What Are The Consequences Of Not Having Cash Flow Clarity?
Just like we are not able to clearly see through the foggy eyeglasses what’s in front of us, when we don’t have cash flow clarity, we don’t have answers to some critical questions like:
- Can I afford to take a BIG investment in my business journey?
- Do I have enough to pay taxes on time?
- Do I need to borrow cash to fund the business or cash flow from operations will be sufficient.
As a result, you may be stuck in financial analysis paralysis, fear of losing money, and may not take action or you may make a bad judgment without knowing the cash flow facts.
As a consequence of these misconceptions and mistakes, entrepreneurs pay a heavy price just like Andy and Sam.
Here’s Andy’s Cash flow story.
Andy Gould’s story – Failing To Chase Companies For Payment
Andy was a little unlucky with his cash flow issue. He actually did everything that he should have done, including projecting his likely cash flow position into the future. The problem he encountered was clients who still wouldn’t pay up, despite his requests.
Who He Is
Andy runs a supply chain platform company that uses the latest data technology to solve common challenges in the sector, such as automating shipments and doing away with cumbersome manual entry. Because the brand’s products are so valuable, each client is often willing to pay thousands of dollars in subscription fees every month.
What Did He Do And What Went Wrong?
Unfortunately, as Andy soon found out, clients can be slow in making payments. And the larger the client, the slower they seem to be. Some brands, he reports, took up to six months to pay the money they owed him in the past.
What Was The Biggest Cash Mistake He Made?
At some points, problems became so bad that he had to start using invoice factoring companies. It became too costly for him to chase up firms that refused to hand over the cash that they owed him. Missing out on $10,000 in his bank account for a few months was, in his words, “devastating.”
Lessons Learned
To get around this problem, Andy changed his approach. Instead of manually invoicing clients for using his supply chain software solutions at the end of the billing period, he charged them at the beginning. Then he automatically cuts off services for clients who don’t renew, just like any other subscription service.
This approach got rid of late payments and put control back in his hands. Now operating cash flow issues are no longer a worry for his firm.
And here’s Sam’s classic cash flow story
Sam Wilson – Being Too Generous With Payment Terms
WHO HE IS
Sam Wilson’s company focuses on helping clients overcome technical challenges they face using an array of technologies, including the cloud. The nature of the work means that it often takes a long time to bring a client from where they are right now to where they want to be. Many times, the solutions that Sam offers require them to make difficult organizational changes – something that can take many months to complete.
What Did He Do And What Went Wrong?
Sam got into trouble when he didn’t make enough of a distinction between cash flow and profit. His company believed that offering generous payment terms would be a great way to get customers through the door and spending. But, it was a strategic decision that ultimately backfired.
Naturally, like most entrepreneurs, Sam wanted to give his clients as much payment flexibility as possible. It didn’t seem right to him that clients should pay part-way through a contract.
What Was The Biggest Cash Mistake He Made And What Was The Misconception He Had?
Unfortunately, he ran into trouble because of the high value of each contract. Customers were routinely paying $10,000 (and more) per project. But that money was taking many months to actually get into the company accounts. The balance sheet looked healthy, but the cash position was a disaster.
Lessons Learned
Sam uses a different strategy. He says that nobody should wait longer than 60 days for payment. He suggests that companies currently operating on a 30-day invoicing model move to bi-weekly. That, he says, will prevent them from having to wait too long for money.
FAQ
Cash flow VS Profit
Look, if you want to go from cash flow confusion to cash flow clarity so that you can avoid cash flow situations like Andy, Sam, Carole, Alan, and Dave, pay attention to what I am going to share with you.
I am going to share with you a FIVE step proprietary process to have instant cash flow clarity. This will be for you for any sector, any stage, and any scale of the business. The best part of it all, is you don’t have to become a financial ninja to do this.
Let’s do this.
How To Have Cash Flow Clarity – Step By Step
In order to have cash flow clarity, first decide what you are trying to achieve, meaning whether you are looking for :
- Cash flow stability instead of cash flow rollercoaster OR
- Cash flow sustainability, while you are scaling the business and you want to watch out for the speed of growth.
To make the process simple, break down the cash flow in bite-size chunks so that you can have better cash flow clarity.
Aim to have cash flow clarity in these three areas.
Cash Flow From Operating Activities:
This category is what most people imagine when they consider business “cash flow.” It is the cash balance that results from a company’s regular operations. Paying staff wages implies negative cash flow while receiving payments from clients is positive cash flow. For example, an accounting company that sells accounting services experiences positive cash flow every time a customer spends money on their services.
Cash Flow From Investing Activities:
This category describes the cash flowing in and out of the company from the purchase or sale of income-generating assets. So, for instance, cash would flow into your company if you sold warehouses or buildings you no longer require.
Cash Flow From Financing Activities:
This category describes the flow of funds from lenders to your company account. So, for instance, a venture capitalist might deposit $25,000 in company accounts every month implying a positive cash flow of $25,000. Negative entries here imply that a company is servicing its debt – that is, paying back a venture capitalist, plus interest. It can also include things like the cost of stock repurchases and paying dividends from profits to owners.
Business growth has to be congruent with cash flow demand. As a business grows it demands cash flow to invest in different areas. So as long as the cash flow, not profit, can handle business growth, you are in a good cash position.
I am going to walk you through a 5 step cash flow clarity proprietary process. This is the exact same process I go through when I work with my clients so that they can have instant cash flow clarity. These clients run businesses with revenue ranging from £40k to £40m a year.
Step 1
Refer to your cash flow statement prepared on a cash flow foundation organized into 3 sections: cash flow from operations (CFO), cash flow from investing activities (CFI), and cash flow from financing activities (CFF).
Remember, a cash flow statement is like a mark sheet of your cash performance. Learning to read a Cash flow statement is an important part of your cash flow foundation. If you think you don’t have a cash flow foundation in place, I suggest you go ahead and build your cash flow foundation by clicking here.
Step 2
Decide what the question is about – stability or scaling the business.
- For e.g. Is my cash flow healthy?
- How much cash do I need to survive?
- How do you tell if a company is financially healthy?
- Can I afford to pay my existing bills can be a stability question,
Whereas can I afford to make the next BIG move to my business to the next level with a scaling question.
Step 3
If the outcome you want is cash flow stability- refer to the cash flow from the operations section in the cash flow statement. Look for TRENDS, Irregular activities, Patterns, and Spikes in the last two quarters. You will gather cash flow insights on how well you are transforming profit into cash flow. AND does the current cash flow support your current and near-future cash outflows? Devil is in the details.
If the outcome is about scaling, you need to refer to CFO and CFF – go through the section in detail. This is because scaling means cash flow demand to invest in the right areas. It is common cash generated from operations may not be sufficient to support the speed of business growth and there may be a need for external funding. Again, look out for TRENDS, Irregular activities, Patterns, and Spikes in the last two quarters. You will gather cash flow insights on how well you are transforming profit into cash flow, cash flow reserve, and whether you need external funding or not.
Step 4- Next Step Is To Follow The F.i.t. Process.
This formula is based on the F.I.T. acronym, where F stands for FORMULA, I stands for INDICATOR and T stands for TARGET.
Let’s look at each of these in detail.
F – Formula
So here is a cash flow formula to use relevant to the outcome you want in steps 2 and 3.
For example: If you are seeking stability (in step 2) then pay attention to cash flow from the operating activities section and follow these formulas:
The operating cash flow formula is a measurement of metrics business’s cash inflow and cash flow outflow. It shows how well a business can generate positive cash flow to support its business activities within a specific period.
The formula for operating cash flow is :
Operating cash flow = PBIT +- changes in working capital non-cash expenses – taxes
Operating cash flow ratio = Cash flow from operations/ Current liabilities
The cash flow forecast formula shows what your future cash position will likely be today.
Here’s the cash flow forecast formula:
Current cash balance + Forecasted Cash inflow – forecasted cash flow outflow = Forecasted cash closing balance
On the other hand, if you are seeking to scale the business, then pay attention to cash flow from operating activities and cash flow from financing sections.
So, follow these formulas.
Operating cash flow formula which I described above PLUS
Cash flow forecast formula which I described above as well
AND
FREE cash flow formula
The free cash flow formula as the name suggests is how much cash is free to be invested into the business and to be taken out by the owner as distributions. Free cash flow is the amount remaining after paying for operating expenses and capital expenditures.
FREE CASH FLOW = CASH FLOW FROM OPERATIONS – CAPITAL EXPENDITURE
Let’s now understand what I stand for in the F.I.T. process.
I – Indicator
Once you have chosen the formulas relevant to the cash flow clarity outcome, you need to benchmark your progress from the previous quarter till now.
You measure how you are performing compared to your cash flow projections. What are the trends, irregular activities, patterns, and spikes you can see that tell how you are performing, to identify cash flow gaps, improvement areas in the business to create cash flow? This leads to setting up your cash flow target.
Now, we come to T in the F.I.T. process.
T – Target
Prepare a cash flow projection at the end of the quarter to set your cash flow target for the next quarter. Then, as you prepare a monthly cash flow statement, establish the cash flow gap between your actual monthly cash flow statement vs your quarterly cash flow projection broken down by months. How far are you month by month reaching our cash flow projection target, which was set at the end of last quarter?
By going through this process, you’ll be able to answer questions like:
- Can we invest in new equipment without risking a cash flow shortage?
- Do we need to cut operating expenses, to survive?
- Do we have enough to cover fixed costs?
- How much profit can I re-invest in the business?
- How can I make my cash flow better?
So that you can avoid:
Situations where you don’t have enough cash to pay your employees on time
Sleepless nights
Lost opportunities
Step 5
What you don’t know and can’t see are the two biggest killers of the business. Seek an extra pair of eyes to avoid what you don’t know and can’t see. I cannot stress enough the importance of having an extra pair of eyes and ears in your business. Someone you can trust to highlight things you may have missed as well as things you don’t know. A third-party expert helps you see those
Story of Steve Butler – A Marketing agency owner based in West London.
Here’s Steve’s story
WHO HE IS
Steve runs a marketing agency business based in West London. He founded this business five years ago. The business is doing well and currently doing around £250,000 a year.
What’s His Cash Flow Clarity Question?
Steve was with me on a Zoom call and asked me, “I have a question for you, Shishir, how much cash is enough for my business?
Here is how our conversation went after that.
Shishir: “Steve, what’s the context behind your question? What are you trying to achieve?”
Steve: “I want to know whether I have enough cash to pay all the bills on time without any problems. As you know I work with big brands, they pay me in 60 to 90 days, and I always worry if I have enough cash to pay the bills on time, especially salaries at the end of the month.”
Shishir: “Steve, share with me a cash flow statement for the last three months. Is it updated as of last month? What’s the bigger picture here? Your question is how much cash is enough to ensure the survival of the business right?
Steve “Yes “
What Did We Do Together?
We followed the following steps.
Step 1
Shishir – “ Let’s set up a routine to update every single month’s cash flow statement. Now, having prepared an updated cash flow statement, Steve let’s move on to step number 2.
Step 2
Shishir- “ Steve, are you trying to achieve an outcome related to having stability in your business, or are you trying to achieve whether you can scale the business to the next level and do the cash flow supports the growth?
I understand that you wanted to be sure whether you can have cash flow stability or not because your question was how much cash is enough to pay all the bills on time. So we have established the question is about stability not scaling the business. Let’s move to step 3 Steve.”
Step 3
Shishir “ Steve, to ensure stability we need to look at the Cash flow from the operations section in the cash flow statement.
The cash flow from operations tells you how much cash is generated from the existing operations in your business, which means how well you are turning profit into cash flow.
In the cash flow from operations section, you want to be looking at trends, irregular activities, patterns, and spikes (TIPS) in the last period. Is there anything that suggests your attention to TIPS? Also, how much cash is generated every single month, and how much cash is paid out in the same period, As a result of this is there a pattern of positive cash flow every single month?
Steve, now we have looked at TIPS, to analyze the cash flow statement then let’s move on to the next step.”
Step 4
Shishir– “ Steve, now I want you to go through the fit process which is F for the formula to use I for indicator so that you can benchmark, and finally T for the target to hit.
As the outcome you want is about stability and accordingly you looked at cash flow from operations so the formula to use on this one is for operating cash flow formula.
So take your profit before interest and tax figures which you can find in the profit loss statement and then you need to add changes in working capital and also add noncash expenses and then deduct taxes and that equals your operating cash flow formula.
Let me explain in detail.
Profit before interest and tax you can find these figures in the income statement OK that’s easy.
Next changes in working capital: which means your receivables and creditors so that’s the changes in working capital now you also need to factor in non-cash expenses like depreciation and then deduct any taxes to pay so that’s how much you have left in your business.
I can see you made a profit before interest in tax is $50,000 and then you have $30,000 to collect from your client and $20,000 to pay to your creditors which means a change in working capital is $10,000 and there’s the depreciation in your profit loss of $1000 and you have $5000 to pay taxes.
So your operating cash flow formula is $50,000 plus 30,000 minus 20,000 plus 1000 minus 5000 which is 56,000 that’s your operating cash flow”
Steve, “Shishir, this is really helpful. We are in month 2 of this quarter. I targeted to have an operating cash flow balance of $80,000 at the end of this quarter. So, we are a bit behind on our target at this rate.
How can I make my cash flow better? Can you share 4- 5 ways to keep the cash flow flowing? “
Shishir – “ Steve, have you created backend products, or thought about what you can offer to your existing clients as repeat purchases, maybe even bundled products and services, fix cash leaks, or even pre-sell your products?”
Steve- “I will look into them, Shishir. If I want to grow my business, how much profit can I reinvest in my business?”
Shishir “ Steve, now your outcome changed from stability to scaling the business. So you need to go through the exact 5 steps to have cash flow clarity, but this time the question is about scaling rather than stability.
So again, Step 1, to prepare a cash flow statement for the last quarter which you have already done. I would also want to go back at least one quarterback so that we are looking at the last two quarters as a base.
Step 2- this time is about scaling the business.
Step 3- Because this is about scaling you need to look at cash flow from operations as well as cash flow from financing sections., if you want to bring in external sources of funding.
Step 4- Go through with the F.I.T process.
This time F- Formula to use are:
Operating cash flow formula – how much cash is generated from operations
Cash flow forecast – what your cash flow position will look like if you go ahead to reinvest profit by say 15%, 25%,45%.
Begin with cash balance + forecasted cash inflow based on current sales projections – cash outflow based on current commitments = cash flow forecasted balance.
You want to set up a minimum cash flow balance so that you have a cash cushion for at least 6 weeks extending to months.
As long as your forecasted cash flow balance can achieve that you are in a good position to -re-invest profit.
How much to re-invest depends on how quickly you want to scale, how much leftover cash you need to support your personal lifestyle.
Finally, you also need to look at the FREE cash flow formula, when it comes to reinvesting profit.
How much cash is FREE cash flow?
Meaning
FREE CASH FLOW = Existing cash balance + Cash flow from operations – capital expenditures.
Do you need to make any capital expenditure for the next 6 months, Steve? Like buying new equipment, vehicles, fixtures, fittings, etc?”
Steve- “ Yes, I need to buy 3 computers for 3 new staff members and also build a new working space – 3 new computers – £500 each – that’s £1,500 and new working space – £3,500- so it’s £5000.
Shishir- “ Ok, your FREE cash flow is cash from operations – which is your cash inflow £25k – cash outflow £15k from trading activities plus opening cash balance £35k and you deduct capital expenditure of £5k.
So, its £35+£25-£15-£5k= £40k
Out of £40k to invest, go back to cash flow forecast, and choose a profit re-invest % so that you have at least a minimum 6 weeks cash flow cushion at the minimum cash flow target to have, even if everything fails if you want to speed the growth as much as possible.
If you want to have more cash flow cushion increasing from 6 weeks to months, that would be great. Because business is not about going fast, it’s about going further.
What you want to do, I can’t make a decision for you.”
Where He Is Now?
Steve- “Thanks Shishir, Food for thought. I will go back to complete this exercise and come back to you. I feel I have cleared the foggy eyeglasses and actually clearly see, where do I stand cash flow wise and what I can afford to do, without sacrificing my survival of the business and without lost opportunities as well”
Steve got his cash flow clarity on his cash flow stability and also on scaling his business fast.
Your Next Step
Now it’s your turn.
Go through the 5 step process and share your experience of tagging me on social media.
If you want to have instant cash flow clarity on your cash flow position, so that you have peace of mind if things are okay or not, take this cash flow clarity quiz.
[QUIZ] When it comes to having cash flow clarity, what is your #1 business blindspot? Take the quiz and find out your specific situation in less than 60 seconds.
This quiz will give you a personalized diagnosis of your situation and recommend the best course of action to take in less than 60 seconds which will be emailed to you.
These are the same questions I ask when I’m diagnosing my clients’ cash flow challenges who are doing revenue ranging from £40k to £40m. so, wherever you are in your business journey this will work for you.
Take the quiz and I will see you on the other side.
