From my experience as a cash flow expert, I’ll share how you can build a solid cash flow foundation so that you can ensure financial stability and scale your business fast in a profitable and sustainable way.
I’ve worked with hundreds of clients in the UK over the last two decades with annual revenue ranged from £40k to £53.8m.I have termed them the 7Rs for building a cash flow foundation.
Here’s the thing.
The name of the game is stay in the game until you win the game
How you stay in the game of business is by building a solid cash flow foundation.
I have used these 7 R’s to build a solid financial foundation for my clients. They are in different niches. These include retail, e-commerce, dental practices, marketing agencies, art galleries, event management, coaches, and consultants.
Maybe you are in a position where net income is not used as the expenses are increasing due to the current state of the economy.
Possibly, the vendor is chasing badly for payments.
Perhaps you haven’t been able to pay yourself a decent salary for a while, and it’s frustrating despite working so hard.
Potentially, loan repayments are having a massive dent in your bank balance.
You can resolve these issues by building a solid cash flow foundation.
This guide will help you with tax planning to affect cash flow. It will also help you control debt to minimize its impact on cash flow.
Before going forward, you might wonder who Shishir Khadka is and why you should trust me.
As a cash flow specialist, I work with small and medium-sized enterprises. I have shared my expertise and experience on this topic through major sites like QuickBooks Online, Independent, Zoho, and Floatapp.
I specialize in building a solid cash flow foundation for my customers so that they can ensure financial stability and scale the business in a sustainable way.
This is my main occupation. I run my own consulting company, Hungry Cash Flow Ltd, using my proprietary cash flow maximisation software, Hungry Cash Flow. It takes care of your cash flow forecasting to perform cash flow calculations so that you don’t have to use a manual system.
So, don’t worry. You are in safe hands.
Let’s dive in.
Key Takeaways
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- There are seven R’s you need to get a handle on to build a solid cash flow foundation.
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- I have seen common mistakes that my clients make. I have shared what you should do for each area when you build your cash flow foundation.
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- If you are concerned about your financial health, take this free cash flow health assessment, which will guide what you need to do to build a solid cash flow foundation.
Have you heard this saying, “You can’t build your castle on quicksand and expect it not to sink?”
It’s so true when it comes to building a business.
You can’t build a business without cash. You need a solid cash flow foundation so that your business can survive when times are tough and thrive when times are great.
To build a solid cash flow foundation for your business, do the following:
(To make them easy to remember, I have organized them as 7 Rs).
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- (ROOT) – Find the Root cause of the cash flow problem
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- (RESPONSIBILITY)– Take responsibility for your cash flow
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- (READ)-Learn to read the cash flow statement
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- (ROUTINE)– Adopt a routine that drives results
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- (RATIO)– Understand cash flow ratios
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- (ROI)– Know your cash flow return on investment
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- (RELATION)– Understand how financial statements are related to each other
Root- Find the Root Cause of the Cash Flow Problem
What Do I Mean by the Root Cause of the Cash Flow Problem?
A person keeps having high temperatures and takes paracetamol to reduce the fever.
After taking paracetamol, the fever returned, and he didn’t know why. He has body aches, is constantly sweating, and has a sore throat.
He thought he just needed to take paracetamol to fix the problem. When it didn’t, the patient went to see the doctor. The doctor examined and found out the root cause of the fever was tonsillitis because of a cold, viral throat infection.
The patient took the medicine the doctor prescribed for a throat infection. Not only did he not have a fever, but he also got rid of body aches, sore throat, and sweating.
In this case, cold virus tonsillitis was the cause of the problem. Not the fever, which is a surface-level problem.
Similarly, in business, you must go deeper to find the root causes of cash flow problems.
I remember conversing with one of my clients, who sells luxury goods. I told him £98k ad spent generating only £500k sales is the root cause of the problem, whereas not generating enough sales to have positive cash flow is the surface-level problem.
Going even more profoundly, he had been spending heavily on Google ads. They accounted for around 60% of marketing ad spending, but only brought in 50% of sales. In contrast, FB ads spent 25% of the total, contributing to 37% of the sales, and surprisingly, the average order value of the sales from FB traffic was much higher.
In his case, it wasn’t the operating expenses that were the root cause; it was the direct cost of ads spent, which wasn’t profitable.
Why Do You Need To Find the Root Cause of the Cash Flow Problem?
There’s a saying in retail. Retail is in detail, and evil is in detail.
If you want to find a diamond, you have to look deeper. Same in business, you must dig deeper and find out the root cause of the cash flow problem.
If you don’t find the root cause, chances are you will never be able to solve your cash flow problems, just like a person who couldn’t get rid of a fever.
What Is A Typical Cash Flow Mistake When Finding the Root Cause of the Cash Flow Problem?
Not Tracking Your Marketing Spend Properly.
Marketing is one of the most significant expenditures for growth-oriented companies. Even then, we don’t take the time to understand which marketing channels perform well for your business.
This is important because you want to deploy your resources in places that give you good returns. Use that to grow your business. You may be stuck where you are without it for a long time.
Responsibility- Take Responsibility for Your Cash Flow
The word accountability comes from the word accounting. If you want to be rich, you need to be accountable for your cash flow. – Robert Kiyosaki.
He couldn’t have said anything better. Taking responsibility is being accountable for your actions.
If you are wondering, isn’t that the job of my accountant or a bookkeeper? You need to be crystal clear about your responsibility.
What Does Your Bookkeeper Do?
Your bookkeeper will allocate the money in and out of business. Your bookkeeper can also prepare the cash flow statement for you. You don’t have to prepare on your own.
Your bookkeeper can record transactions to allocate expenses and payments received from a customer. However, he can’t protect your cash flow.
You can outsource the task of preparing a cash flow report for you. However, you cannot outsource the responsibility of managing cash flow because it’s your cash flow.
You are responsible for becoming a financially savvy entrepreneur and being accountable for your cash flow.
What is your responsibility, then?
Your responsibility is to understand how the cash flows from your client into the business and your bank account and make cash flow decisions accordingly.
Cash flow Mistakes entrepreneurs make when It comes to taking responsibility for cash flow.
Why Does A Small Business Owner Make a Mistake Of Not Being Accountable for Your Cash Flow?
It is usual to think you can sell more and build a successful business.
That’s part of the equation. But it does not guarantee cash will stay in business.
See, it’s not about getting rich. It’s about staying rich in the business.
To do that, you need to learn to manage your cash flow. It takes time and effort. The starting point is not leaving this responsibility to your accountant.
Most entrepreneurs leave the task of managing finances to their accountants. Accountants are like mentors and not a coach. They can give you tried and tested strategies and tips to protect your cash flow. However, that doesn’t mean the strategies are working right now. There’s a big difference between that.
Read- Learn To Read the Cash Flow Statement
Your ability to read a cash flow statement can be the difference between a business that barely survives and one that thrives.
There’s a problem if you think I don’t know how to read a cash flow statement.
Have you gone to a foreign country and realized that you struggle to communicate because you don’t speak the local language? It’s so frustrating!
Isn’t it the same when you don’t know how to read a cash flow statement? It suddenly looks like a foreign language because you don’t understand what it means.
The language of business is accounting- Warren Buffet
If you don’t know how to read the cash flow statement, then you will not be able to identify:
trends – What are the trends of cash inflow and cash outflow
irregular activities – Are there any irregular cash flow activities that you need to be aware of
patterns- Any specific patterns developing in your cash flow
Are there any spikes up or down? If so, why is that ?
You want to see and understand your cash flow. If you don’t understand it, how can you expect to communicate your cash flow decisions to others or even to yourself? Because a confused person can never make a decision.
Here’s what I believe.
If you can’t read, then you can’t communicate. If you can’t communicate well, you can’t convince the bank for funding to fix the cash flow gap you may have right now. You want to show how much cash flow you have right now. You also want to show how much you need to borrow, for how long, and when you can repay the bank or angel investor.
Routine-Adopt a Routine That Drives Results
A cash flow statement is a mark sheet of your cash flow performance. So you need to have an updated cash flow statement regularly, i.e., monthly cash flow or weekly cash flow, to be on top of cash flow.
How?
Routine drives result in setting up a routine. Regularly prepare and analyze cash flow statements. Identify trends, irregular activities, and pattern spikes.
You don’t just prepare a cash flow statement once a year or when you have to submit it to the bank.
You set up a routine on a monthly, weekly, and quarterly basis. This helps you see trends in cash inflow and outflow, irregular activities, patterns of certain items, and spikes. It helps you understand why they happened in your business. This makes the process powerful. For example, let’s say you did a one-off JV partnership to offer your product, and some people bought it, and suddenly, you saw a spike in cash flow. Maybe you made a bigger purchase in a particular period. That is why there is a spike in cash outflow.
The key is to analyze the cash flow information and relate it to the commercial activity.
Ratio- Understand Cash Flow Ratios
Let’s learn more about cash flow ratios.
What Is a Cash Flow Ratio?
The cash flow ratio is a ratio that tells us if the cash flow your business is generating is enough to meet current liabilities.
How Is the Cash Flow Ratio Calculated?
Cash flow ratio formula = cash flow from operating activities/current liabilities.
Why Is the Cash Flow Ratio Important?
The cash flow ratio is important. It reveals the cash position in relation to the financial aspect of the business. The cash flow ratio is a more accurate measurement of the business’s liquidity.
What Is a Good Cash Flow Ratio?
A ratio greater than 1 indicates good financial health for a business. It shows that the business has enough cash flow to meet short-term financial obligations.
In other words, means that cash flow is greater than what the business needs to meet current liabilities.
A ratio of less than 1 indicates short-term cash flow problems.
As an entrepreneur, you don’t need to go through ratios for academic purposes. You need the cash flow ratios that affect your business performance.
I am going to share with you FOUR crucial cash flow ratios you should be aware of:
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- Cash flow to sales ratio
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- Operating cash flow ratio
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- Cash Conversion Cycle
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- FREE cash flow ratios
Let’s go through them one by one.
Cash Flow to Sales Ratio
Cash from a client is very different from sales to that client.
Let me explain.
You sell your £6k package, which lasts for three months. So you have to deliver your service for three months.
Option 1
The client pays in full.
So in month 1, you received full payment, but you only earned 1/3 of the sales as you delivered 1/3 of your services.
So your cash flow to sales ratio = 6000/6000 = 100%
Option 2
The client pays in 2 instalments
So in month one cash flow to sales ratio= 3000/6000 = 50%
Option 3
The client pays in three equal installments
So in month one cash flow to sales ratio = 33%
Why is the cash-to-sales ratio essential, and what’s its use?
The cash-to-sales ratio reveals cash-generating ability per sales volume. If the cash is tied up in debtors, the business can’t re-invest cash, although the business has made a profit.
Operating Cash Flow Ratio
The operating cash flow ratio formula = cash flow from operating activities/current liabilities.
You can find cash flow from operating activities on the cash flow statement. You can find current liabilities on the balance sheet.
The operating cash flow ratio shows whether the cash generated from operating activities can pay its current creditors.
Cash Conversion Cycle
The cash conversion cycle is the number of days from which sales are converted to cash.
If the sales invoice is dated 1 January 2021 and the payment is collected on 10th January 2021, the cash conversion cycle is ten days. The fewer the days, the better the cash conversion cycle
Free Cash Flow Ratio
The free cash flow ratio is an amount rather than a ratio.
Free cash flow formula= Cash generated from operating activities- capital expenditure- working capital needed.
ROI- Know Your Cash Flow Return on Investment
CFROI measures your cash flow in relation to marketing. It’s for a specific project or team. Etc. in terms of capital invested in the business.
This shows how a business finances its operations and how investors are paid.
This gives you an idea of what worked and didn’t work so that you can double down on the things that worked for you.
Here’s the CFROI ratio formula
CFROI = Cash Flow Return on Investment
RELATION-Understand how financial statements are related to each other
HOW ARE THE THREE FINANCIAL STATEMENTS LINKED?
Three financial statements – the income statement, the balance sheet, and the cash flow statement – are linked together. They usually act as guides to one another. Fitting together, they paint an overall picture of your business and its financial health.
The cash flow statement is vital to the other two because it will show increases and decreases in cash flow over an expressed period of time. The others will be the end-of-year statements, while the cash flow fills in the blanks between them. So, in a sense, the cash flow acts as the plot of your business year. It’s easy to see
where you ended up by looking at the other two, but how you got there is left up to the cash flow statement. This is how the statement of cash flows is connected to the balance sheet.
Looking at a cash flow statement in isolation does not tell you everything you need to know about your business. It also doesn’t show your cash position. You need to look simultaneously at the balance sheet and profit and loss statement. Here’s the link if you want to go deep into this section.
Summary
In this guide, we looked at how you can build a solid cash flow foundation in your business.
I always say the name of the game is to stay in the game until you win the game. You stay in the game of business to go further in your business by building a solid cash flow foundation.
Your Next Step- Take the Assessment
If you are concerned about the financial health of your business, I have created the FREE assessment quiz tool to identify the areas that affect the cash flow foundation. Tag me on LinkedIn, how you get on.
ABOUT THE AUTHOR
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Shishir Khadka, qualified as a chartered certified accountant in 2009. He is the creator of cashflow hub– the world’s most comprehensive cash flow resource online and is one of the UK’s leading cash flow specialist who helps busy business owners and entrepreneurs generate more profit and create consistent positive cash flow without over relying on getting new sales.
He has delivered a masterclass to a global software Zoho’s audience to create consistent cash flow. He has written articles for floatapp– one of the leading cash flow software and has also been featured in the major publications such as Independent. He has been sharing his learning and insights on his youtube channel.
He wrote about his learnings from helping an e-commerce client scaled the business cash flow positive from £500k to £1.6m in four years in “The Three Key Obstacles to Faster Growth: How You Can Overcome Them Using Cloud Accounting.”
In his career spanning over 20 years as the cash flow specialist, he has helped businesses of all sizes, ranging from £40K to £53.8M.
