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Title: Walking the Tightrope between Operating Expenses and Optimal Cash Flow
Description: Learn how to balance operating expenses with optimal cash flow in your small business. Get expert tips to improve your cash flow statement.

 

Walking the Tightrope between Operating Expenses and Optimal Free Cash Flow for Small Businesses

In this article, we will be looking at what OPEX is and why I emphasize it so much when discussing the cash flows of my clients.

Ever had that moment where you’ve just wrapped up a fantastic month of sales, and you’re pretty chuffed about it?

But then, you take a peek at your bank account, and it feels like someone’s played a cruel joke. The numbers just don’t add up. Where’s all that hard-earned money gone?

Let’s dive into the world of Operating Expenses (OPEX) – those sneaky little costs that can play havoc with your bank balance and cause serious cash flow problems.

MISSING COMPONENTS

  1. Diagram- where to find opex P&L)- when paid – Cash goes down in Balance Sheet.
  2. TIP-
  3. Mistake or misconceptions
  4. EXAMPLE

Key Takeaways

Operating Expenses (OPEX) are essential day-to-day costs that businesses cannot avoid, including rent, salaries, utilities, marketing, insurance, and licenses.

OPEX can have a significant impact on cash flow, and understanding the balance between income and expenses is crucial for a healthy business.

Monitoring and managing OPEX is essential for cash flow stability, budgeting, safety buffers, flexibility, and future opportunities.

  1. Practical steps for managing OPEX include budgeting, regular reviews, cost-cutting, negotiation, automation, outsourcing, and energy efficiency.

What are Operating Expenses (OPEX)?

Alright, let’s break it down. Think of OPEX as all the costs you as a business owner incur just to keep the lights on in your business. These are the regular, day-to-day expenses that keep your business running.

These are the essential costs that you cannot avoid, regardless of the level of activity and they appear on your income statement.

Some Classic Examples of OPEX are:

Rent or Lease Payments: One of the most significant expenses for many businesses, especially those with a physical presence. Whether it’s a retail store in a bustling city centre or an office in a commercial district, rent can eat up a significant portion of your cash flow.

Salaries and Wages: Your team is your most valuable asset, but also a significant cost. This includes not just the basic salaries, but also bonuses, benefits, and any other compensation.

Utilities: These are the basics – electricity, water, heating, and internet. They are generally fixed

Marketing and Advertising Costs: Whether it’s online advertising, print media, or public relations campaigns, marketing expenses can vary widely based on your strategy.

Insurance and Licenses: Depending on your industry, you might need various licenses to operate. Additionally, insurance is a must-have to protect against unforeseen events.

The Relationship between OPEX and Cash Flow (and profit)

At its core, a cash flow statement represents the movement of money in and out of your business. It’s the lifeblood that keeps the business running, and understanding it is crucial for sustainability and growth.

Cash Inflows

This is the money coming into your business. Primary sources include:

Cash Outflows

The money going out of your business. Major outflows include:

If your business has inflows higher than outflows then you have a “Positive Cash flow” and you are “Net Cash Positive”

Conversely, if your outflows surpass your inflows you have a “Negative Cash flow” and you are “Net Cash Negative”

Clear a misconcenception!!

“You need to understand that you can be a net cash negative business in a certain period but still a healthy business, for instance, you have spent a significant money in building up inventory levels for the upcoming Christmas season.”

But keep an eye out if your operating cash flow is negative which means the cash inflows you generate from sales are lower than your outflows for OPEX, if that is the case then my friend you have a problem which needs to be addressed ASAP!

A balance between Opex and Cash flow Management

Maintaining a healthy cash flow isn’t just about boosting sales; it’s equally about managing outflows. High OPEX can significantly strain your cash flow, even if sales are booming.

It’s like having a bucket full of water (sales) but with several holes (OPEX) causing leaks. The challenge is to ensure the water level (cash flow) remains steady and increasing.

The Impact of OPEX on Cash Flow:

Light Bulb Moment!!

“You might believe increasing sales is the best way to improve cash flow. In reality, effectively managing OPEX can have a more immediate and significant impact on cash flow than simply boosting revenue.”

Difference between Cash Flow Statement and OPEX:

understanding the relationship between OPEX and operating cash flow can be distilled into a simple equation:

Cash Flow = Total Income – OPEX

While this formula offers a high-level view, the nuances lie in the details of each component we use to calculate cash flow.

Total Income:

This covers all revenue streams, from product sales to returns on investments & gains on disposal of assets. Diversifying income sources can provide stability, especially if one stream faces challenges.

OPEX

As we’ve discussed, OPEX includes a variety of expenses. Understanding the breakdown helps in pinpointing areas for optimization.

Fixed vs. Variable OPEX: Not all expenses are created equal. Recognizing the difference between fixed and variable OPEX can aid in better financial planning.

Fixed Costs: These are expenses that remain relatively constant, regardless of business activity. Examples include:

Variable Costs: These fluctuate based on the volume of business activity. Examples include:

Nuances of OPEX

While categorizing expenses might seem straightforward, there are nuances that you should be aware of.

Capital Expenditures vs. OPEX: Some costs, like research & development or investments in long-term assets, might seem operational but are capital expenditures.

Depreciation: This is a method of allocating the cost of a tangible asset over its useful life. While it’s a non-cash expense, it impacts profit and, consequently, cash flow indirectly.

Non-operational Expenses: These are costs unrelated to the core operations of a business, such as interest paid on loans or one-off legal fees. While they impact cash flow, they aren’t considered OPEX.

Clear your concepts!!

“Do Not confuse capital expenditures (CAPEX) with OPEX. This misunderstanding can lead to financial mismanagement, as CAPEX investments are meant to benefit the business over the long term, while OPEX is immediate operational costs.”

Why Monitoring OPEX is Crucial for Healthy Cash Flow?

1. The Snowball Effect

Small expenses might seem harmless when you look at them in isolation. However, if left unchecked, these can accumulate over time, leading to significant cash outflows. It’s similar to how a snowball grows larger as it rolls downhill. Before you know it, what seemed like a minor cost has now become a major drain on your resources.

2. Forecasting and Planning

Regularly reviewing and understanding OPEX allows for better cash flow forecasting. Having a business plan is crucial for making informed business decisions, from hiring new staff to launching a marketing campaign.

3. The Safety Buffer

A controlled and optimized OPEX ensures that businesses have a financial safety net. This buffer is essential during business downturns, unexpected expenses, or external economic shocks.

4. Flexibility & Opportunity

High OPEX not only affects your current cash flow but also limits future opportunities. Money spent on excessive operating costs is money that could have been invested in growth opportunities, such as expanding product lines or entering new markets.

Emily’s Real-life Example

 

My Friend Emily runs a lovely Coffee Roastery, The sales were good, and the aroma of freshly roasted coffee beans filled the shop, but the numbers didn’t add up. They were consistently running into cash flow problems.

Despite her strong passion for her business, she found herself constantly juggling between what to pay first and what to delay and it had started taking a strong toll on her mental peace and overall team morale.

Emily decided to work with me to solve this problem at the root level. When we took a closer look at her OPEX, we discovered that:

Emily knew she had some changes to make immediate changes to ensure the business’s sustainability and growth:

Rent Negotiation: She approached her landlord and negotiated a lower rent, leveraging the loyalty of her customers and the unique charm her coffee shop brought to the neighbourhood.

Salary Restructuring: Emily restructured her team’s compensation, focusing on performance-based bonuses rather than fixed increases, which incentivized efficiency.

Energy Efficiency: She invested in energy-efficient appliances and adjusted the shop’s heating and lighting, reducing utility bills significantly.

Digital Marketing: Emily shifted her marketing efforts to digital platforms, allowing her to target a more relevant audience for her niche and measure ROI accurately.

Fast forward 8-10 months:

And believe me, it’s not rocket science, and a similar process of review and control could also get you some impactful results from low-hanging fruits.

Practical Steps to Manage OPEX & Improve Cash Flows for Small Businesses:

Budgeting:

Every business, regardless of its size, should have a budget. It acts as a financial roadmap, guiding you on where and how to allocate resources.

Allocating Funds: Determine how much you’re willing to spend in each category of OPEX. This allocation should be based on past data, industry benchmarks, and future projections.

Staying on Track: Regularly compare actual expenses against the budget. If you’re consistently overshooting in a particular category, it’s time to reassess and adjust.

Future Planning: Use your budget to plan for future expenses, such as equipment upgrades or expansion plans.

Regular Reviews:

Just as you’d review your business strategy, it’s essential to periodically check your OPEX.

Monthly Check-ins: At the end of each month, review all your operating expenses. Look for any anomalies, unexpected spikes, or areas where costs have gradually crept up.

Quarterly Deep Dives: Every quarter, take a more in-depth look. This is the time to assess the effectiveness of cost-cutting measures, renegotiate contracts, or explore alternative suppliers.

Tools & Resources: Equip yourself with the right tools to monitor and manage OPEX effectively, tools like QuickBooks, Xero, or FreshBooks can help track expenses, generate reports, and offer insights into your financial health.

Cost-cutting and Optimization:

It’s not about slashing costs recklessly but about spending wisely.

Negotiate: Whether it’s with suppliers, service providers, or landlords, always look for negotiation opportunities. Even a small percentage off a significant expense can lead to substantial savings over time.

Bulk Purchases: If storage allows, consider buying frequently used items in bulk. This often leads to better per-unit pricing.

Automation and Technology: Invest in technology that can automate repetitive tasks. For instance, using accounting software can reduce the need for manual bookkeeping, saving both time and money.

Outsource: For tasks that aren’t core to your business, consider outsourcing. It might be more cost-effective to hire a freelance graphic designer than to have one on staff, for instance.

Frequently Asked Questions (FAQs)

  1. What’s the difference between OPEX and CAPEX?
  1. How can I differentiate between essential and non-essential OPEX?
  1. Are there tax benefits associated with OPEX?
  1. How can seasonal businesses manage OPEX effectively?
  1. Can I reduce OPEX without compromising on quality?
  1. How often should I review my OPEX?
  1. Are there any industry benchmarks for OPEX?
  1. How can technology help in managing OPEX?
  1. What should I do if my OPEX is consistently higher than my industry peers?
  1. How can I ensure that cost-cutting doesn’t demotivate employees?