Optimizing Cash Flow
The first thing I'm gonna start on is ah, slide from the power point, optimizing cash flow. Um, in addition to, I think when I was playing out of your the two most important points that I wanted to make was the segregation of duties discussion that we had last time yesterday that I thought that was really important. Optimizing cash flows runs a close second. Remember, we said it many times, but it bears repeating. There's two areas that tie up your cash, the most accounts receivable for everybody if when you build people and then if you carry inventory inventory. And the analogy that I used is if you started business January 1st with $50, and now it's April 1st and you've been profitable from January 1st to April 1st. But your cash balance has gone down from $50,000 to $10, you say to yourself, How can that be? I was profitable. I'm billing and I have more. I'm building and I have more revenue and sales and I have expenses. How can my cash balance me so much lower? And the answer is it...
's because it's tied up in other places, the biggest of which is accounts receivable and inventory. At the end of yesterday segment, I did something on the operating cycle of how we spend cash and collect cash and spend it again. Think about that from yesterday segment as we start into this section. Now, this section starts off with some more concrete examples about planning your cash flow. And I've got some little phrases below there that I hope will spur some thinking. The first is, Did I invoice that client? I am notorious for this. I feel like it takes me a lot of energy and effort when I'm with a client online giving consulting, training on accounting. Invariably, when I'm online, I get to the end and I forget to tell him how many hours we were together, what the rate is and how much they should send me through PayPal. I can't tell you the number of times half the time I forget to say that it's a lot more effective to tell people what they owe and ask him to pay you in a in a live situation that it is to email of an invoice. So I have to always remind myself asked for the payment at the end of this conversation because that's the best way to get that payment in. So we'll talk about that Mawr. What's my checking account? Balance. As you know, my son Shout out to Connor, the checking account balance is burned through quickly. What this means to you, though, is you gotta know how much cash you need every month to the best of your ability. I understand a lot of us don't know how many projects we're going to do, but we probably have an idea of the cash for each project. We might not know if we have five projects or seven, but we probably know the count. The cost for per project. What I'm getting at is we can at least estimate how much cash we need. And if we can estimate how much cash we need, then we could deal with Well, how much cash do I have? How much cash do I have? And how much cash do I need to operate? My business number three is a point that I talked about yesterday, which is if I'm adding clients, are they paying me on time from adding clients are they paying me on time now again? Part of this is financial, but part of this is also personality. I've had people over the years that I love working with the pay me late and I'm willing to live with it because I really liked that client. Yeah, as Jackie O we're talking about. We're talking about less segment with charities. If somebody is in a real crisis, I always tell my clients this. Look, when I was coming out to creative life and I knew I was gonna be unavailable for this three day segment, I said, Look to my customer, Mark. I said, Look, Mark, if you get stuck and you're studying for your MBA final and you get stuck, I'll find a time to call you for 10 minutes to get you unstuck. And I'm not gonna charge you for 10 minutes. It may be online, and maybe just over the phone. I don't want you to sit there and be stuck, you know, apply that to your clients. I'm sure there's plenty of times when you do something quick for a client that you don't build for just because you want to keep the relationship and you like your client in the same way you may be willing to tolerate clients he paid late because you like the client where they always pay or they're a big client or some combination. All right, so I'm hoping at the beginning of the segment to solve a critical problem, and I said it in this course before. Most businesses don't fail because they're losing money. Most businesses fail because they run out of cash. Now. They may not even fail, but they may have to go borrow money or sell ownership when they really don't want to, because they don't have enough cash to get through the next three months. Six months, etcetera. So while you stay in business, you end up doing something you'd prefer not to do. Okay, accounts receivable and inventory client type cash. I mentioned this story, but it bears repeating of this example of Pawel the plumber, who had plenty of revenue but was short on cash worth saying again because this is so critical in its example of a big A cup, a guy running a big company who was successful and in demand but was keeping himself up a night because of his cash position. I mean, it was literally making the guys sick. Paul has a residential plumbing business that does $3 million a year in sales. Everybody, we all get our plumbing fixed immediately. It's always there's always a need. People always pay because you want to have a good plumber. I mean, I think you really need to get him moved to a new city. You really did a good auto mechanic and you got to find, you know, a good handyman. If that's not your thing, that is not my thing. That is not my thing. And you gotta find reliable plumber. You gotta find reliable people. Paul was very reliable. He had business coming out of his ears. OK, but what Paul didn't do and it's the last line there is. He didn't carefully consider how to use cash, and he made a big mistake. The mistake that Paul made, I'm gonna go back and finish it there before I go on. The mistake that Paul made Waas, he was in the residential business. That's the business that he knew. He took some cash and invested in a commercial business which was putting plumbing into a commercial building, and it lost money. And because it lost money, he lost some of his cash that he used in the residential business. The business that he knows as a result of that he was constantly sure cash. He's only about a week short, but he's constantly short, and he's never able to catch up the moral that story is two things. First of all, carefully consider how you use your cash in the business that you know and be cautious of going into a business and investing in something you don't know. A big decision I have to make is, and I've talked to some of the producers about it. I'm gonna start a slightly different business that is just geared toward consulting with businesses, and I've got to make a decision on how much money I want to spend on a website. I talked with someone a creative lives, spent $ on a website and it was a home run and this person got all kinds of business. Well, you know, I'm going into a new field a little bit new for me. It's gonna be for me a pretty big expense. It's cash out the door and I have to cash flow everything else in in the meantime. And that's the conversation I'd like you to have with yourself. New area Got invests in Cash How does that affect the business that I already know about over here? Because I could tutor people online forever. I know how that works. I know how much to charge. I know how to build him. I know what to do. I know that's easy for May I could do that, my sleep. But now I'm thinking about doing something new, and it's gonna require a cash investment. And I've only got a bucket of so much cash. While I hope that the new business will have big revenue and profit until I get there, it's going to require sucking out some cash out of the bucket into that new business. And that's risk. So you've got to consider that did I am voice that client. It's common sense, but we so often forget in my example of not telling people with the only online bill your client as soon as possible and make the payment easy. I take PayPal for payments online, and I also use one other service that actually is going out of business. And I had a pay button for them on my site that I'm gonna have to remove, but make it easy. So what do we mean by easy email in the invoice? Send him. If you're sending a physical good, put the invoice in the box. You could also email it, make payment easy, give him a link to the whole. I have a link to the home page of my sight. Here's where you go to pay me Scroll to the bottom Boom. Make it easy, Easy. I I don't even have time to the point where I don't even have a checkbook. All of my stuff is electronic all my payments or electronic all my payments from clients or electronic. In fact, you may consider offering a discount if clients pay you Elektronik Lee rather than by check. Nobody gives me checks well, that I take that back. My book publisher gives me checks. Other than that, I don't get chucks no checks quicker. Easier send an invoice when you deliver your product or service, not separately. That's big, too. Offer an online payment system using PayPal a payment button on your site. That's great to one of the reasons to spend money on your site. In addition to being creative, showing people what you could do it center and creative lives a beautiful side. I've told everybody here I thought the site was beautiful is to make payment easy and to make navigation easy. Which is why our hosts tell you how to navigate at the beginning of these segments each day. Debit credit card. That's obvious. Let me talk about discounts again. Offer a discount for early payment, but only in special situations. Because, as we mentioned, people are going to expect to get that discount every time. So you need to coach your client. Are you only giving him a one time discount and that everything else is going to be a full boat? You get a coach, your client on that just to make that clear. Okay, Uh, the starting point for cash is what your balance now, So a reconcile bank balance is your starting point for calculating your cash needs. What's your balance now again, I highly recommend that you reconcile your bank statement within five days of getting the banks you reconcile within five days of getting the bank statement now, practically today, because you can get him electronically. You're gonna get your bank statement on electronica pretty quickly. Please reconcile within five days so that if your records don't agree with the banks records, you're fixing it and resolving it sooner than later reconcile within five days of receiving your bank payment. US bank statement statement. Now, now, let's go to kind of the process of planning your cash. First thing you got to do. And I know this is hard and it's it could be a wide range. Depending on how many projects you do, most of you were doing project work. Estimate your sales for the month. Mrs. Boy gets angry when I overestimate my revenue for the month. That creates anger and gnashing of teeth for a biblical gnashing of teeth. So, to the best of your ability, estimate your sales for the month. So in my example here, I'm gonna forecast $3000 photography sales this month. Your best estimate step to estimate your profit as a percentage of sales. Earlier today, we did profit margin. In this example, it's a 10% profit margin. That means you earn $300 profit on $3000 in sales. The rest of it is cost. The rest of it is cost. Compute the costs you'll incur to generate the sales. Well, $3000 at a 300% profit. 10% means that 90% is your cost. This is an issue that most people don't consider, which is. They don't consider that we all get excited about making a sale. But we don't think about the costs related to that sale because you're were you know, we got the jazzed up, were euphoric about getting the sale. We don't think about the cost. And the question is, once we know that 90% of that $3000 sale is cost, where you gonna get the cash? Where will you get the cash? Adding customers who, on average don't pay us quickly can reduce your cash flow. Now, I touched on this yesterday. I'm gonna do it again because it's so critically important. Critically important. Guarantee you if you're watching this course now and you grow your business six months down the road, if you haven't had this conversation about cash flow with yourself or watch the video again. Or talk to an accountant or talk to somebody in your industry, it's going to get you in a bind again. Not that I'm the answer to all your problems, but that you need to address this. Please address this, whether through me or somebody else. Adding customers who on average, don't pay us quickly reduces your cash flow. So we said in the last example that your cash flow is $2700 a month. Now I'm gonna introduce a new thing, and it's in yellow. The average time to receive a customer payment is 20 days. So in 30 days I'm not going to get all the $2700 back. In theory, yes, result the entire $2700 costs it's collected within a month. What's the cash impact? There's no need to add cash for the next month. Now we have a situation where your pay your cell mawr, but you're paid more slowly. This relates to getting in an area of business that you're not that experienced with like me. So I have a very specific plan to do one on one intensive It's got to be in person consulting with business owners, and it's very targeted and there's about problems I can solve. And, Mr Client, if you don't have these 12 problems, good luck and God bless you really can't help is very specific. But here's the variable I don't know. The variable I don't know is how quick are gonna get paid, because over in Ken online training land I get paid right away. But in new consulting land, how soon will I get paid? Because I could get myself in a situation where WiFi combined the two businesses overall. On average, I get paid to slowly to cash flow. I get paid to slowly to cash flow. Here's an example. Revenue goes up to $4000. That's good. The profit margin is the same. It's a 10% profit margin, which again means 90% cost 90% times $7600 a month is my cost. Revenue goes up. Costs go up to Here is the problem. In comparison with the prior slide, the average time to receive the customer payment is now 40 days, not 30 not 20 or 30. The problem is I'm not recovering all my costs within 30 days, which means after 30 days, I need more cash to do business. Okay, Big, big, big issue. I'm gonna take that example. I'm going to do something I did yesterday because it's so critical. Other than segregation of duties and the fictitious pay, this cash flow is the most important thing. In my view, that you'll take out of this class is a viewer. Okay? We talked about an operating cycle. We get an order. We spend money to fulfill that order. We deliver a product or service could be either one. We collect money and we turn around and we do it all over again. And the point I was trying to make yesterday the goal is a couple goals. Okay, I didn't do it in this format yesterday, but let me do it. Try to care. Clarify. There's a couple of goals in the operating cycle, for one. I'd like to if I can reduce the outflow of money to create the product or service. We talked about that when we did target net income and break even. I'd love to lower my variable costs by getting a new supplier. I'd love to lower my least cost the fixed costs by re negotiate my lease. So part of the goal is I'd love to spend less money. Another goal is related to cash flow. I'd like to collect the money faster and speed up this process for all of you out there. You need to think about how long does it take me, on average to collect money if it takes you 20 days. If it takes you a day, think about that. Because how fast this circle moves has everything to do with whether you're gonna have enough cash to operate. Okay, let's do that example from yesterday. It's so critical we flipped to a new page because I'm gonna do a couple of steps. Okay? Yes. I have a question about even how you organize your business and whether it's pusher pool, whether you're b two b or B two c business, the business, our business, the customer for me, some of my products We don't even go into production until we have an order. Until I know that you've ordered $20,000 of X y widget. I'm not even going in production because it costs me too much toe produce it and store it for that different thing. So how does all that factor into that? You're actually in better shape And let me pull this back over for a couple of reasons. You're not carrying inventory, which means your cash is not being a by inventory and you're not spending the money until you get in order. While some people are spending the money on inventory three months before they sell something, you're not spending the money until you know you have an order. So your cash flow cycle is faster, so those are two good things. Ideally, it would be great if everybody could avoid spending money until they had an order. That would be that's ideal. Okay, Her delivery product would be slower, It may be yes, which means let's just put some days on it. And this is this is the psychology of when I put days and 40 days on average time. Let's expand that. If it takes you 20 days to make the product and 30 days to collect the money, you're not gonna get around back on the cycle for 50 days to give an idea So now, you know, 50 days from the time they call in place the order until the time I get the money in here. It's 50 days. Businesses know this. Big businesses know this. They got it down to the day on average. Okay, I'm gonna touch on something you can do to for budgeting That expands on the cash flow that I did yesterday. I think there's a QuickBooks template on it, but I think you could just do it in excel. Okay? And I'm just gonna call it a cash forecast. Okay? You have a beginning balance and can't. Let's say it's February. We have a beginning balance in cash abbreviating 50,000. We're gonna have inflow, and we're gonna have outflow. And at the bottom, we're gonna have an ending balance. And you should know that the ending balance in February is gonna be what for March. It's gonna be the beginning balance for march. So whatever a number I end up with here at the end of February is gonna be my beginning march, and now you can see visually. Oh, yeah? How much gas do I have in the beginning of a large? Because what you want to avoid is to have some of your cash outflow as a new bank loan or selling interest in your business to get enough ending cash to get to the beginning of the next month. Okay, cash inflow is going to be receivables in your business, and that's gonna be based on past month sales. So you estimate based on people who owe you money from January and people owe you money from December. Still, at the beginning of February, you estimate that $30,000 is going to come in. That's a plus. That's a positive number to fulfill to spend money toe to make your product or service. That's gonna be an outflow. I'm just gonna call it new production. That's gonna be an outflow of 40,000. The reason you're gonna have this bigger outflow number is that you're adding business. Okay, great news that you're adding business, but it requires more outflow. So if I add it all up, my ending balance is now $10,000 lower, which becomes my beginning balance for march now because I sold Mawr because I created and sold more product of February. You would think that my receivables in March, you're gonna be higher. Let's assume you collect within 30 days you're going to collect the whole 40,000 plus 40,000. But you increase your sales again in March. So you're outflow in March is now I'm going to say it's 50,000. My ending balance is doubt. Now down to 30,000. That was right. Hesitated. So here's what's happening in this business. You're selling more stuff. That's good. Receivables were going up, but the money that you're paying out for product is also going up, and your ending cash flow is going down. Now, All of these variables concert nly change Don't get me wrong. But this is the kind of this in excel Easy, easy peasy. This is the kind of analysis that you should do for yourself, and you can have separate schedules that say Okay, you know, I'm over $5000 in from December and I'm owed $25,000 from January, and that adds up to or here I'm gonna have X amount of sales, and I know that 70% of that is cost. And that's how I got the 40,000. So these numbers may be figured out below. And then this is your master document. And so these air figured out blow here on a spreadsheet, and then this is linked to this, and the inning balance in March is linked to April. See what I mean? And it's called a rule forward. It rules forward on account, would call it a roll forward. Okay. Ratios that relate to receivables and inventory one more time. So critically important. Comparing for receipt listing receivables first. And we're talking about ratios looking at sales versus receivables. You could do this a couple of ways when I talked about yesterday. One I'm gonna introduces new A simple way to look at it. What is my average receivable for the month? So one month euro 10,000 1 month, year old, 12,000. I'm just talking about an average. I'm gonna make up a number and say it's 10, compared with your sales of 100,000. I gotta put dollars. I'm breaking my own rule. I gotta put dollars by these numbers. What that means is is that you are quote and I didn't use this term yesterday, turning your inventory turning over that receivable 10 times in a year if this is annual so what that means is is that you collect all of your receivables and sell $10 worth of $10,000 with stuff and collect it, Sell it collected, sell it collected seller collected 10 times. The goal would be to minimize your receivable and to maximize your sales so that you're turning it and turning it and turning it faster and faster and faster and faster. Hey, I'd love it if my receivable was only 505 $100 I was selling $100,000 a year. Well, they be great. Tom, Tom, Tom, Turn, turn, turn. Okay, because the less receivables you have, the more cash you have. Less receivables, ISMM or cash. All things being. You know, if I've got 10,000 receivables and sold 100,000 that means I got 98 90,000 cash. If I've got $50,000 receivables and sold 100 I've got $50,000 in cash. Okay, what kind of business would that be? More obvious, the sales versus of receivable situation. But I'm not sure if I see how that would apply in like a photography situation. It applies to businesses where, um, clients traditionally take a longer time to pay or take a longer time to pay. Maybe not the whole bill, but some of the bill. So the construction business people to do commercial construction. I have friends in that business. I wouldn't want to be in that business for this. And this is one of the reasons if you're in a business where you do progress, billing and you may do this if you're a creative person in your work, where you build people as you finish a percentage of the project. So if the jobs $100, job, when I'm 20% done and I can prove to you that I'm 20% done, I get paid 20% or $20,000. It's called Progress Building. That is an industry where that would be applicable. Yes, So anyone? I'm glad you brought it up in a Anyone who bills can only bill your client in increments because they want their cash. Has this issue has this issue? Okay, that's receivables. Let's talk about inventory. Compare average inventory on average. You know, sometimes it's 50,000. Sometimes 30,000 your average inventory with your cost of sales. Now, let me just reiterate, because we saw it in QuickBooks. When you sell an item and inventory inventory is an asset. When you sell it, it becomes a cost of sales and expense. When you have an item and when Candace has an item and inventory, it's an asset because she could make money by selling. When she sells it, it becomes cost of sales, which is an expense. You've used up the asset in this instance by selling it all right, just to clarify these two terms. Okay, let's say, on average, Candice's inventory is $30,000 put a dollar sign, and her cost of sales is 300,000. Same thing here. She is turning inventory. In this case, they call it inventory turnover 10 times, which means, in theory she is. She she opens up her warehouse door. There's $30,000 of inventory on the shelf on January 1st. She is selling all the inventory and buying all new inventory 10 times during the year, and the idea again would be. I want to minimize the inventory that I carry because it ties up cash, and I want to maximize my cost of sales. The Jackie O says, Well, I don't start production until I have an order. So she does not have inventory, which would be ideal, which would be ideal. So what we've done is two things. Remember what two things tie up your cash beginning of this segment, receivables and inventory. How can I get a handle on whether or not I'm doing a good job collecting cash? Here are two ratios to comparisons really easy. You could think about this in the car, you know? Well, my goal is to sell 300,000 this year, and lately I've been carrying $30,000 of inventory. You might think that's good or bad, because if you reduce the receivables in the inventory and you increase your sales, which is comparable to cost of sales, you tie up less cash and you and you collect cash. Sooner said you want not only less receivables, but you want less inventory because this ties up your cash so we want less of it. This ties up your cash. I want less of it. Receivables. Inventory reduces