Archive for Cash Flow

Two Basic Financial Mistakes Entrepreneurs Make

As an entrepreneur, learning the ins and outs of business accounting or finance is usually pretty low on the priority list. Especially when dealing with the myriad daily challenges of starting and running your own business.

But whether entrepreneurs do their own bookkeeping or hire a bookkeeper to handle tracking their financial records, having a basic understanding of both the Profit & Loss Statement and Balance Sheet is a “must learn” entrepreneurial skill.

To truly understand your business’ financial position, both financial statements need to be looked at together. Simply relying on your accountant or bookkeeper for interpretation is not a way to build your business.

Financial Mistake # 1: Profit and Loss Statement Tunnel Vision

All business owners want to make a profit, so they naturally obsess about their Profit & Loss Statement (P & L). Clearly, Revenue and Expenses are always top of mind with small business owners, but it’s only part of the financial picture.

You ignore your Balance Sheet at your peril.

OK, that sounds kind of dire. But the result of doing so can be serious.

Rarely have I met an entrepreneur who realizes that looking at only the P & L may lead them straight into a cash flow bind…until they are in one.

Business failures caused by serious cash flow problems are all too common. But understanding and properly managing Balance Sheet Assets and Liabilities can help prevent that.

Your Balance Sheet is where your “cash flow warning system” is located. And you can use simple financial ratios to keep an eye out for problems too.

Don’t get me wrong, you still need to focus on profitability, but Accounts Receivable, Accounts Payable, Loans, Inventory and Fixed Asset purchases all affect cash flow. And balances in those accounts show on the Balance Sheet, not on the P & L.

Knowing how to use that information and carefully managing those balances can help avoid some nasty financial surprises, so taking steps to learn how to read both statements is very important.

Financial Mistake #2: Not Understanding the Accounting Method in Use

Or worse yet, mixing them together, which I’ve seen multiple times. There is no way to manage cash flow or know your true bottom line unless you know how your business finances are being “booked” in accounting parlance.

There are two methods of accounting: the Accrual Method and the Cash Method.

They are very different from a financial reporting standpoint and depending on the type and size of your business, one may definitely be better than the other for you. This is something to discuss with your accountant when opening your business.

Generally, I prefer accrual under most circumstances but sometimes the cash method is preferred.


Don’t Confuse Cash Flow with Profits

Old Accounting Ledger with alphabetical tagCash Flow and Profit are two concepts that can be confused, particularly by business owners who are unfamiliar with the accounting techniques used for recording Sales and “Accounts Receivable” when running a business.

It is possible to make a Profit and still be caught in a cash flow bind. And cash flow problems can put you out of business in spite of making a profit.

Cash Flow is Very Different from Profits

Profit represents the excess of your revenues over your expenses. Put simply, your Sales revenue in any given time period exceeds your business expenses for the same period.

Cash Flow represents the actual flow of sales receipts and cash disbursements in your business. You receive payments for your Sales and deposit those payments in your account. You then make disbursements for your expenses.

If your expense disbursements are less than your receipts, your cash flow is positive.

If disbursements are more than your receipts, your cash flow is negative & must be covered by borrowing or by some other means.

Keeping Both Profit and Cash Flow Positive

To succeed in business, you need to make a profit and you also need to have positive cash flow.

Actual business losses will ultimately create cash flow problems – that’s pretty obvious.

But here are some typical scenarios that can sneak up on you to create cash flow problems:

• Letting your Accounts Receivable aging get out of control will ultimately hamper your cash flow.
• Building up inventories that are paid for with current cash can be problematic if there is much of a time lag between the purchase of the inventory and the sale of the products.
• Investing in fixed assets such as capital equipment, tenant fit-out, office furniture or equipment expenses can use up significant amounts of current cash, so proceed carefully.
Not keeping accurate records about project and business expenses can make it seem as if there is more cash in the business than there actually is.
Incorrectly accounting for deposits on projects can also backfire. When you receive a deposit at the beginning of a job, your expenses for the job have not yet been recorded, so your cash balance includes money that is probably already committed to expenses that aren’t yet showing on the books.

Don’t Get Caught Short

To stay on top of cash flow:

• Keep accurate business records and remember that competent Bookkeepers are good business investments.
Be clear about your payment terms with your clients & stay on top of your collection process. A good bookkeeper can help with that too.
Run credit checks on your clients before extending them credit. If they can’t pay you, their cash flow problem will quickly become yours.


Avoid Cash Flow Woes

Managing your business’ cash flow is as important as watching your bottom line.  Small businesses and startups operate on tight budgets and sometimes shoestrings, so cash management is critical for survival.

Two of the most common pitfalls that occur with cash flow are:

Mistaking Cash Flow for Profit

This usually affects businesses that receive substantial deposit money upfront (e.g., construction), but that aren’t accounting for job costing and deposits correctly. When business is busy and a lot of upfront money is flowing in, owners can easily overspend and then be caught short of cash at the end of the project.

Mistaking Profit for Cash Flow

Focusing only on the bottom line without keeping a close eye on cash flow can destroy a business. A cash flow crunch happens when a business’ accounts receivable and accounts payable age on incompatible timelines. For example, if your collections from clients age substantially, but your payments to vendors are due quickly, you can end up in a cash flow squeeze that can bring your business to its financial knees.

Avoiding a Cash Flow Crisis

There are a number of ways you can stay on top of your cash flow. It starts with keeping accurate and up-to-date financial records and reviewing them at least monthly. Better yet, review your customer accounts receivable aging weekly to make sure customers are paying you on a timely basis. Keep an eye on your Accounts Payable aging too. If your accounts payable shows that your business is starting to accumulate a bunch of overdue bills, it indicates a cash flow problem.

Good record-keeping is critical to managing a healthy business. Hiring a bookkeeper to handle this task for you can be an excellent investment on two counts: you’ll have a timely and accurate financial picture and you can spend your time building your business, instead of attempting to keep up with collections, orders, purchases and job costing minutiae at midnight.


Speeding Up Accounts Receivable Collections

paid invoiceAll business owners know that collecting money from customers can sometimes be a frustrating and lengthy process.  This can be particularly tricky in a service or consulting business.
When selling products, businesses often collect a deposit or get paid in advance before shipping but consultants tend to bill after their services are rendered. This means you effectively don’t have any leverage with your client. And if you don’t have someone else doing your accounts receivable collecting, you are also placed in in the uncomfortable position of pursuing a client over a bill at the same time you may be pitching them for new business.

There are a several techniques that can help.
1.  Get a retainer up front if you can and apply it to the final invoice, not the first.
2.  For a fixed fee project, break the project’s deliverables down into billable sections and send the bill in a timely fashion so that you don’t go too much further in the project without being paid for the work already done.
3.  Accept credit cards so that it is easy for your client to pay. This can be particularly effective when dealing with other small business owners when their cash flow is tight.
The downside of using credit cards is that you’ll be subject to fees. But that’s just a cost of doing business and can be calculated easily when you are deciding whether or not to offer this. If you don’t already accept credit cards, a fast and easy way to do so is with a PayPal business account. It allows you to accept all major credit cards and you can even invoice your clients directly through PayPal via email. The information can be downloaded directly into your QuickBooks accounting file and easily transferred to your bank account.