Cash is king when you're starting a small business, that's no secret. Managing your cash flow can be incredibly tricky for many types of organizations.
Whether you're responsible for paying contractors, have a particularly heavy payroll, or simply have a thing product margin that you're responsible for, cash can run out incredibly quickly if you're not careful. If you're quickly running out of cash, there are numerous levers that you can pull to ensure that your business survives a downturn.
Of course, the first step to ensuring that your business never runs out of that sweet, sweet green is to take preventative measures!
How to Monitor Your Cashflow
Cash moves in and out of a business like blood flows through your body. It's generated with sales, circulates throughout a host of different expense categories, and profit often gets repurposed to help the system stay afloat. Understanding how much money your business cycles through each month is incredibly important so that you can maintain a healthy cash balance!
Cash flow monitoring actually starts with excellent bookkeeping. Bookkeeping is simply the process of tracking your business' financial story by recording revenue and expenses. By creating an accurate record of the expenses that your business spends money on as well as tracking the amount of cash in your reserves, it's easier to paint a picture of your where the money goes!
All businesses have a "burn rate". Your burn rate is the amount of money your business needs in a certain period (like a month) to cover all of its expenses. By painting an accurate financial story through bookkeeping, you can deeply understand how much your business is bringing in every month through sales, how much it's spending in every category of expense, and how much profit is left over at the end of the month.
Combining the understanding of these three factors (sales, expenses, and profit), you can easily measure how much cash you need on a monthly basis and how long your current cash balance will last!
Here's an example: let's say your business is making $25,000 per month in gross sales revenue. Through your bookkeeper, you're able to identify that you're spending $30,000 per month across several different categories of expenses. This means that you're losing $5,000 every month!
Your business currently has $30,000 in the bank; only one month's worth of expenses. Since your expenses are spread out throughout the course of the month, your bank balance tends to stay relatively even as sales steadily come in through the door, but it can fluctuate by about +/-$5,000 depending on the week. Since you're losing, $5,000 every month, you'll burn through your cash reserves completely after 6 months of spending if something doesn't change. Because your bank balance also tends to fluctuate by +/-$5,000 each week, that timeline becomes much shorter.
There are two major factors for improving the amount of money that you bring into and retain in your business: you can either increase sales or lower your expenses. Sounds easy enough... right?
How to Calculate and Improve Profit Margin
One of the biggest contributing factors to the amount of money in any business (whether you're selling products on the internet or services to locals) is your profit margin. The profit margin is a simple calculation measuring the sale price of the item or service you're selling minus the cost and associated expenses to produce it.
This is a relatively easy concept to understand for physical goods; if your business purchases goods at a discount and resells them at a higher rate, your profit margin is easy to calculate! It becomes trickier to think about in service-based businesses.
Regardless of the kind of business that you're in, there are costs associated with the thing that you're selling. If you're a loan officer helping people get into mortgages, your cost of goods includes things like processing fees, employment verifications, appraisals, etc. If you're a web designer, your cost of goods are things like hosting fees, keyword planning tools, and design software.
Your cost of goods eats away at the amount of money that you keep when selling a product or service; the measurement of the amount that you keep is the gross profit margin! To calculate the percentage, simply take your net sales amount and subtract your cost of goods. Then, divide that total by your cost of goods.
If I'm selling a photography package for $1,000 and the service costs me an average of $200, my net profit is $800 and my profit margin is 80%.
To improve your profit margin in any business, you can either increase the amount that you're charging for a product or service or work on reducing the costs that go into producing it.
Identifying Expenses That Can Be Cut
An effective way to increase the amount of cash retained by your business is to cut down on your spending.
It can seem intimidating to have to cut off large amounts of spending, but when you're in survival mode, it can mean the difference between life and death. Adjusting your marketing budget, tightening up on spending for meals, negotiating different payment terms with vendors, and more can result in thousands of dollars in savings.
Unfortunately, the largest cost of almost any company is payroll.
Payroll is expensive, no matter how you slice it. If your business is experiencing a downturn, adjusting payroll can provide substantial relief to ensure that your business can stay open. Many employee benefits are wrapped up in the total payroll cost, as well. If you're offering "nice but not necessary" benefits like a work-from-home stipend or gym memberships, for example, these make for more digestible cuts. Laying people off is the last resort when you've exhausted all other options for cutting your expenses.
Are there other options?
While it may seem obvious, the most effective solution to encountering a slow season or running out of capital is to plan ahead. Make sure that your business has an emergency fund, monitor your cash flow, and create plans for when things don't turn out how you'd hope.
Many people look to take on debt when their business slows. While debt can be useful to grow your business, it is not a long-term viable solution for a failing business.
Debt financing is extremely risky and can create a bigger hole in your financial situation than you're already in. Instead, ensure that you're bringing in enough cash through sales and keeping it by lowering your expenses, then explore alternative options for expanding and growing your business.