“In the end, a vision without the ability to execute, it is probably a hallucination” – Steve Case Co-founder AOL
Steve’s statement largely reflects my view on cash in business…Whilst it is important to be in business for a higher purpose than purely money, without that money it can become increasingly difficult to commence or continue your business idea.
Some of our clients are extremely profitable on paper having written and secured large subscription based contracts, but when it comes to cash flow they struggle to pay their bills at the end of month. A profitable business can quickly fail if the cash flow doesn’t match the balance sheet.
The first step in managing your cash position is to understand where your business (or parts of it) sits in the cash lifecycle.
- Cash Burn – you will have read or heard the phrase ‘fail fast’. If cash was no issue, then businesses could go on making useless products and services indefinitely. Thankfully, the realities of business require us to develop our minimum viable product, learn from it (quickly) and then pivot or continue. This phase is known as the ‘Cash Burn’ phase and will occur when a business is beginning or implementing change (e.g. new products and services). There is nothing wrong with the Cash Burn phase, provided your business has a clear budget, timeline and deliverables which tell you when and how much to keep spending.
- Cash Stable – The ‘Cash Stable’ phase arises when you have proven your product or service and begin to earn from it. At this point a business’s primary focus is on management of the upward trajectory.
- Cash Positive – The third stage in the cash lifecycle is the Cash Positive phase, at this point entrepreneurs tend to get ‘itchy feet’ and find new product or service offerings to invest in. The crucial point at the Cash Positive stage is to ensure that you do not starve your proven business of cash flow, whilst testing a new idea or concept.
It is rare that the whole of a business will easily fit within one stage of the cash lifecycle at any one time. More often, various parts of a business will be operating in various stages of the lifecycle. That’s the exciting bit, provided that cash flow continues in the right direction over the long term.
There are two sides to cash management, simply Inflows and Outflows. Of course, your underlying model needs to be profitable, but let’s assume you’ve got that sorted.
Every business spends before it generates, so let’s look at Outflows first. Our philosophy on dealing with creditors is simple:
- Bargain Fairly and Firmly – ask everyone for payment terms. They can either say yes or no. That said, you’re suppliers aren’t your bank so agree on terms you can meet.
- Communicate – chances are your suppliers owe someone money, so do them the courtesy of letting them know if you’ll miss a payment deadline. A phone call explaining the delay, should be followed up with an email confirming the payment terms so all parties are clear on the arrangement.
It’s expensive to litigate. In our experience litigation is often avoided by businesses keeping each other informed as to payment status.
A big part of cash management is making sure you’re paid on time, every time. Here are our five fundamentals for dealing with debtors:
- T&Cs – Your Terms and Conditions (T&Cs) govern your relationship with your customer, so it’s vital they tick all the important boxes (e.g. what goods/services are being supplied and at what price, payment terms, security, defects/warrants, IP etc.).
- Perfect the PPSR – If you’re supplying goods on credit, the odds are you will want to retain ownership of those goods until you’re paid – this can help keep you safe if things start to fall off the rails (e.g. customer refuses to pay, becomes insolvent etc.). To do this properly, you’ll need two key things:
- Correctly worded retention of title rights in your T&Cs;
- Valid, on-time & perfected registrations on the Personal Property Securities Register. The PPSR laws are riddled with technical requirements, which if not met can have disastrous outcomes, so it’s critical to approach this task carefully.
- Predict Poor Payers – Some business owners base their cash flow projections on the assumption they’ll receive all customer payments ‘on time’. This can be tempting as it can make the future look brighter, but in reality, most businesses will have some late payers. To accurately budget your cash flow it’s important to include realistic projections of debtor collection dates, whether based on historic performance or reasonable, commercial estimates.
- Follow-up – Speaking with debtors is paramount to getting paid. In addition, have a template demand letter on file. For larger businesses, train your accounts staff to issue demands and attach copies of unpaid invoices automatically after a suitable period (e.g. 30 days).
- Lawyer up – For long overdue accounts (e.g. 60+ days), sometimes all it takes to finally get paid is a legal letter of demand. The escalation from your in-house demand to a legal demand made by a lawyer, coupled with the threat of litigation, shows increased seriousness and is often enough to motivate payment.
Our hope is that fundamentals 1 – 4 will avoid business owners needing to progress to the worst case scenario of legal action.
Life, Death and Taxes
Taxes and business go hand in hand, yet the Australian Taxation office continues to wind-up in excess of 1,000 companies most years. Business owners often forget that taxes (e.g. GST and PAYG) and superannuation are funds that are not technically available for the working capital of a business.
Whilst, on occasions, businesses must draw upon their reserves to cover short term cash flow issues, we highly recommend that businesses form the mind-set that taxes and superannuation are held on trust for the ‘tax man’ and their employees. The simplest way to do this is to open a separate business savings account and deposit taxation and superannuation into the account when the liability is recorded. This will ensure that a reserve pool exists when it becomes time to remit those funds at the end of the month or quarter.
In summary, ensure the longevity of your business by spending with a goal in mind, collecting debtors on time and ensuring that you’ve put money aside for those inevitable outgoings.