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How Business Owners Can Improve Cash Flow By Thinking Profit First
Entrepreneurs don't necessarily need to be numbers people in order to succeed: You need drive, passion, the ability and will to follow things through, and the hustler's spirit that enables you to constantly try that new thing or relentlessly chase that next big opportunity.
But whether you're a serial entrepreneur or simply looking to grow your small business to a sustainable level then reassess your goals, it's crucial to have an understanding of your venture's financial results. While SMBs don't require the same horsepower in their accounting department as large companies and quickly-growing startups, it's still integral for entrepreneurs of all calibers to have an iron grip on their financial controls, processes, and results to prevent roadblocks.
Your business financials aren't solely about how much revenue the company has brought in stacked up against your expenses, or how many strategic maneuvers can be deployed to minimize your business tax burden. Understanding your key ratios, terminology, and the stories behind your numbers—and having the right accountants and advisors who can help you interpret them—will take you from simple compliance to long-term stabilization and growing your business.
Where Is Your Money Coming From?
And moreover, where is it going?
It can seem like operations are running smoothly because cash is regularly deposited, the bills are paid, and imminent tax filings don't feel like a shakedown where you have to scramble to get the funds together. But while your bottom line might look good on your next attempt to raise capital, you could find yourself in hot water if it turns out that only one revenue stream and/or client constitutes most of your revenue. If that client goes out of business or otherwise decides to stop or reduce their payments, it could be significantly harder to pay back the loan you took out or demonstrate to your investor that you're worth going past seed stage.
Demonstrating that you can make a profit is important for raising capital, but raising capital isn't a be-all and end-all. The time that you spend trying to qualify for loans, grants, and outside investment might be better spent getting more clients, users, views, income-producing property, or other important revenue drivers first. This could prove to be even more important than trying to keep your burn rate (cash outflow) under control: Constrained cash flow is usually why most companies fold within the first two to three years of operation, and often gets overlooked by busy entrepreneurs focusing primarily on raising funds or posting an impressive profit.
Financial Transparency — More Than Just Compliance
In your quest for capital, your focus is likely to be directed toward the numbers investors are going to pay attention to: margins, profit generated relative to the capital you already invested, and how many users you have. But in being transparent about your finances, you're not just being compliant with the law — you're also giving a more accurate picture of where your business currently is and where you expect it to go. Early stage companies are more likely to get investment less so from promising financials and more from showing promise with the actual product and business model, so you don't need to worry about getting the best-looking numbers to show. Banks, on the other hand, have stricter requirements for loan repayment and will be more stringent concerning financial compliance. They will want to see a proven track record and put more emphasis on your profit than growth potential, especially if you're not a very capital-intensive business with significant collateral such as vehicles or real estate to secure the loan.
Improve Cash Flow Management by Putting Profit First
Regardless of whether you go for the more dynamic risk-taking with investor funding or the predictable repayment process with a business loan, all external capital sources will want to see proof of proper cash management even more than having stellar revenue numbers.
The ability to adequately control your cash inflows and outflows is what will help your company weather any storm. One train of thought to help drive profits, is to look at concepts like Mike Michalowicz's "Profit First" model that changes the Revenue - Expenses = Profit expression into Sales - Profit = Expenses. While this is not an official figure to report on financial statements, it's an excellent cash flow management mindset that helps business owners prioritize their personal and business savings so that operating expenses, expansion, taxes, and personal income are always being paid.
By "paying yourself" first, it ensures that your financial results are based on having enough cash on hand before you pay any expenses.
Any small business accountant is required to furnish a cash flow statement to most investors and some banks, but you shouldn't wait until you have one at the end of the month, quarter, or year. Go over your cash flow every week. In addition to expenses that could be cut or revenues that could be added or bolstered, you might have bottlenecks in your cash collection processes that could be eliminated and you hadn't even realized it.
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