Turning Your Business into a Money-Making Machine
If you own a business, you probably agree that turning it into a money-making machine would be ideal. Who wouldn’t want that? Like any machine though, many different parts go into making it turn seamlessly and efficiently. As for your business, that means it needs the parts that make up revenue; the parts that help increase profit, and the parts that drive cash flow. To operate successfully, it needs all three.
In May’s blog, the first installment of our three-part series based on the webinar “Don’t Work the Business, Profit from It,” we discussed the “Sixteen Parts of Your Business that Drive Revenue, Profit, and Cash Flow” by focusing on revenue. In the second blog, we focused on profit. And now, in this third and final installment of the series, we’ll explore what it means to drive cash flow.
Businesses need more than just revenue and profit; they need a consistent and healthy cash flow to sustain operations, fuel growth, and better prepare for financial uncertainties. As important as revenue and profit are, cash flow is the real lifeblood of a company. It helps to ensure that day-to-day expenses, payroll, and unexpected costs can be met without resorting to additional debt or equity financing. It also allows businesses to invest in new opportunities, such as expanding product lines, entering new markets, or upgrading technology. Without it, even profitable businesses can struggle to maintain operations.
Effective cash flow management is critical for maintaining financial health today and allowing for long-term strategic planning tomorrow. And there are six parts you need in place to do that.
The Six Parts that Drive Cash Flow
1. Days Sales Outstanding
This is the number of days it takes you to collect money from customers. Not only are you without cash before a customer pays, but you typically must also incur expenses (e.g., Cost of Goods) to service the customer in the first place, which means you are out even more cash. This ‘part’ drives cash flow in that the longer it takes for you to collect from your customers, the longer you are without cash flow.
Using the HVAC company example from the first two parts of this series, let’s say that you sold a $1,000 air conditioner to a customer and agreed to let them pay for it in three months. Essentially, you are extending credit to your customer for 90 days. This means that, from this one customer, it will take 90 days for you to collect. So, your Days Sales Outstanding in this example is 90 days.
Ideally, you want this number to be lower rather than higher so that you have access to the cash sooner rather than later. However, if this number is too low, you could risk losing out on business because many customers need a more flexible credit policy.
2. Days Inventory Outstanding
This is the number of days it takes for you to sell through your inventory, on average. You purchase inventory with cash and, until you sell it, you will remain without that cash. The cash is, figuratively, sitting on your shelves. This ‘part’ drives cash flow in that the longer it takes for you to sell through your inventory, the longer you are without cash flow.
Let’s say you purchased $10,000 worth of inventory in your HVAC business with the intent of upselling to customers who use your services, and it takes, on average, 120 days to sell through that inventory, then your Days Inventory Outstanding is 120 days.
Ideally, you want this number to be lower rather than higher so that you have access to the cash sooner rather than later. However, if this number is too low, you could risk losing out on business due to not having enough, or the right, inventory on hand, losing customers who will then have to shop elsewhere.
3. Sale or Purchase of Assets
An asset is something that your business owns, such as a truck or a machine. When you purchase an asset, it will decrease cash flow (unless you use debt). But when you sell it, you receive cash. This ‘part’ drives cash flow in when you purchase an asset, your cash flow will decrease and when you sell an asset, it will increase. The timing will depend on when these events occur.
4. Days Payable Outstanding
This is the number of days it takes for you to pay your suppliers. Let’s say it takes you 30 days to pay your suppliers for a recent job. You could get paid from your customer prior to having to pay your costs to service them. For example, if it takes you 20 days to get paid by your customer and you pay your supplier in 30 days, then you have access to excess cash for 10 days that can be used in other ways. This ‘part’ drives cash flow in that the longer it takes for you to pay your suppliers, the more you get to hold onto your cash.
Ideally, you want this number to be higher rather than lower so that you have access to the cash longer. However, keep in mind that your suppliers are your business partners, and they would like to get paid in a timely manner, just like you. Not to mention, many suppliers often provide discounts to their customers for paying early, which can also increase your cash flow.
5. Using or Paying Down Debt
Debt is when you borrow money to fund any part of your business, from operations to marketing to strategy. This money, of course, must be paid back to the lender over time. Debt can come in the form of bank loans, credit cards, or borrowing from friends or family, to name a few sources. Paying down debt will reduce cash flow as you are using cash to pay back the lender. But debt can also be used to improve the financial health of your business if you’re using it to purchase something that will have a return on investment (ROI). This ‘part’ drives cash flow in that when you buy things using debt you are not having to use cash, which improves cash flow.
Before using debt, carefully assess if what you are purchasing with that debt will actually provide a return. For example, if you purchase a machine for $50,000, you should be confident that the machine will provide at least $50,001 in cash flow over its life. Of course, the higher the return the better.
6. Owner Investments or Distributions
Owner investments are the amount of money that the owners of a business invest, from their personal funds, into the business. Owner distributions are the amount of money that any owners of a business take out of their business for personal use. The idea is that any investment will eventually provide the business with an ROI. This ‘part’ drives cash flow in that the more investments there are into the business, the more cash flow will improve. Ideally, of course, one of the primary points of a business is to provide a return for its owners in the form of ‘owner distributions,’ which lowers cash flow.
The Cash Flow Formula
When the above six parts all work together, they can increase cash flow. In conjunction with focusing on the strategies above, the following formula can help you determine where your business is:
- Profits plus/minus –
- Days Sales Outstanding
- Days Sales Outstanding
- Sale/Purchase of Assets
- Days Payable Outstanding
- Using or Paying Down Debt
- Owner Invest/Distributions
- Equals cash flow.
*Each of the Cash Flow parts have a plus or a minus because they can impact cash flow either positively or negatively. For example, if you use debt, it will increase cash flow, if you pay down debt, it will decrease cash flow.
By enhancing one or more of the key ‘parts’ above, you’ll see an improvement in cash flow. Now, picture the impact of optimizing all 16 ‘parts’ that drive revenue, profit, and cash flow simultaneously. The result would be a substantial boost to your business, supercharging your money-making machine!
At Agile Planners, we take care of the numbers, so you can sleep at night. We provide strategic guidance and outsourced CFO services to companies of all sizes. We can help provide the strategy your organization needs for the growth you want. We understand that no two organizations are the same. And with our experience and financial knowledge, we can help develop the right strategic plan for your business to grow and reach its goals. Simply, we’ll be your trusted partner, so you can focus on running your organization. Contact us today to learn more about how we can help.
