One of the biggest obstacles to scaling your company is cash flow. Yet when a company struggles with cash flow they generally have a knee jerk reaction, “We need more sales.” The painful truth is that often more sales is the worst thing for that company, as the cash flow challenge comes from a different cause.
Here is a simple diagnosis tree to follow down to get to the root of your cash flow challenges. You’ll notice that only one is poor sales.
Cash Flow Challenge Cause #1: Poor collection on your receivables.
It’s my observation that many businesses ignore this vital function because they are uncomfortable asking people or companies for money.
Yet the cost to the business can be massive, and only compound as the company grows. Remember, once you make a sale you have all those costs of goods sold. If you don’t collect on that sale you’re actually worse off than if you never made the sale in the first place.
Imagine Acme Inc. has gross sales of $1 million per year, with 5 percent of its sales going uncollected. Well you say, that’s just $50,000 out of $1 million in sales–that’s just the cost of doing business.
But hang on for a second. If Acme Inc. has 20 percent operating margin (i.e. a pretax profit margin) then that $50,000 of uncollected receivables you were so willing to write off as “the cost of doing business” represents an instant increase of 25 percent operating profits if it were collected!
So the first place to look if you are suffering from a cash flow challenge is at your balance sheet and collections practices. Are you collecting all of what you are owed? Are you collecting this money in a timely basis? How much are you spending on your collections efforts?
Cash Flow Challenge Cause #2: Your pricing is off.
Most businesses set their prices when the business is new and desperately needs business, and as a result, set pricing levels low. Over time, the business may make nominal increases to pricing every few years, but rarely does the owner ever sit down and fundamentally rethink his pricing model.
Look at your gross profit margin. That number is a great tool to help you ferret out if somehow your pricing model is off.
This can happen to anyone. For example, I was coaching a CPA firm in Mississippi that was struggling with cash flow. We did a “margin analysis” breaking down their gross profit margin on every client and discovered something. One third of their clients, which we put in to “Bucket A” were high margin clients. One third of their clients (Bucket B) were low margin clients. And the final third of their clients were negative margin clients (Bucket C) which meant they were losing money on every sale they made to these Bucket C clients!
We immediately raised pricing on all Bucket C clients or gently guided them to other firms. Next, we went back to the Bucket B clients and both raised pricing and looked at ways to reduce the production cost to do the service work, both of which improved their margins.
Pay close attention to your gross profit margins, including breaking it down by client or product or service category.
Cash Flow Challenge Cause #3: Your expenses are too high relative to your sales volume.
Costs matter. Early on, business owners know this and agonize over every penny spent. But as the business grows, you will no longer be able to be the hawk watching closely over every dollar spent.
Go through you P&L statement and question every expense, especially the big three–staffing, capital expenditures (e.g. equipment and plant), and office costs. Can you make any cuts? Can you negotiate with your vendors for better pricing? Can you make a fixed expense variable (e.g. paying a performance fee vs a salary, locking in an option to renew versus an obligation, etc.)?
Cash Flow Challenge Cause #4: Your sales are too low.
After looking at the above three cash flow issues, the bottom line cause may simply be that your sales are too low.
Can you encourage your customers to upgrade to higher value products or services? Bundle in complementary items to increase your average unit of sale? Do all you can to reduce attrition so you keep your customers longer? Etc.
So before you rush off to sell your way out of a cash flow challenge, make sure you take a moment to see if that is the real root cause of the crisis.
Originally published at www.inc.com