Cash is king. Managing your cash flow is one of the most crucial aspects to running a business. If your business is struggling, banks won't touch you. The paradox of finance is, those that need money can't get it, and those that don't need it, can. Cash flow is a regular struggle for small businesses. Cash can be tight for a variety of reasons. In this article, we’ll look at three specific cash-flow traps that businesses can fall into.
First trap – Group deals (Groupon started this, but there are many now). Relevant to retail, service and restaurants
Group deals are the Pay-day loan of the business world. It can provide a quick hit of cash, but it will cost you. If you find your business relying on Groupon-type companies to drive customers, you may be in a cash-flow death spiral and not even realize it. Much like a person taking a payday advance from Money Mart, if you start relying on group deals for your cash-flow, you’ll find that before long you’re in a tight spot financially.
Many businesses will turn to group deals to drive customers through the doors, which gives the business a boost of cash. The hope is, these are new customers that will come back again, paying full price. The problem is, there are a number of potential issues that arise from relying on group deals. These include:
1. It cheapens your brand. Customers may begin to look at you as a discount brand.
2. It angers your existing patrons if they find out there was a Groupon deal they missed. Imagine sitting in a spa relaxing, having paid $120 for a massage and the person next to you says they only paid $60.
3. Worst of all, (and the focus of this article) it could actually be costing you money.
How so, you ask? From my experience, a typical group deal works like this: you sell a package on their website, and people pay up front for a discounted service or product. Customers purchase a kind of gift card for less than face value (pay $20 to receive a $40 gift card). They can then come in and use the gift card for a certain time period, after which it will revert back to face value (after March 31, the gift card is worth $20). The business gets the money once the promotion is over and the group deal site takes a cut of around 40% (I’ve seen 40%, but it could be more or less depending on the site). So not only are you offering a discounted price (usually around 50% or 2 for 1, but it could vary), but you also only receive around 60% of the cash, with the group deals company pocketing the rest. You could be selling your product for almost 1/4 of the regular price! For most businesses, this would be selling at a loss. You have to really know your margins to know whether you are making money using this model. I’m not saying its never a good idea. For example, if you are a restaurant with fixed costs like rent, and certain staff members that you need to keep year-round, such as the head chef and other key employees, you may want to get customers in the door to cover your fixed costs. Also, customers coming in for a 2 for 1 appetizer, will 9 times out of 10, also purchase an entrée. But, if you go into this blindly, you could be operating at a loss and not realize it for months, until you wonder where the money went! That is why it is so important to know your profit margins and variable and fixed costs.
Second trap – timing your payments and collections. Relevant to all businesses.
Paying too early and collecting too late is a cash-flow trap that many businesses fall into. There is an old adage, buy low, sell high, collect early, pay late. We all know the “buy low, sell high” part, but we sometimes forget the “collect early, pay late” part. You should be paying your suppliers as slowly as they'll allow. As long as you maintain a good relationship, take advantage of longer terms when you can. If applicable, negotiate longer terms up front. When it comes time to pay, pay on a credit card if you can (make sure to pay the balance when it’s due). This will give you another month or so before the cash is due.
The flipside of this is to stay on top of your collections. In general, an old debt is hard to collect. The person no longer sees any value in paying you because whatever they're paying for is long gone, used up, or is no longer of much value to them. For your own cash flow purposes, getting paid in a timely manner is crucial for paying your own employees and meeting your short term obligations. If the job is longer term, you should obtain progress payments and possibly a deposit up front. If there is a change in the job during its progress, you should consider a change-order. Obtaining the customer’s consent with a change order will make it easier to collect. (Change orders don’t just apply to the construction industry. If you provide a service, and the customer wants something extra, it would be prudent to establish a change order for the revised service and pricing for the new work. Make sure the customer agrees to the change order before the new work begins to ensure they understand there will be a charge for the new service.) If you’re collecting quickly, or upfront, and obtaining the client’s permission for change orders, you’ll be less likely to have old receivables turn into bad debts.
Third trap – spending the CRA’s money. Relevant to businesses that collect GST and/or have employees.
If your business collects GST or has employees, you are an unofficial tax collector for the CRA. The GST you collect and the payroll tax you withhold from your employees is not your businesses money, but rather, you are holding onto it for a short period of time and remitting it to the government. I’ve seen it time and time again, where businesses don’t separate the government’s money from their own money. If cash gets tight, the government’s money gets spent, and then GST or Payroll taxes are late. There are significant penalties and interest (non-tax deductible) when GST and Payroll is late. There is also extra administrative costs because it takes way more effort to reconcile a messy payroll account than it does a clean one.
To avoid mixing up the government’s money with yours, I suggest having a separate bank account for GST collected. You could do the same thing with the payroll withholdings. By doing this, you keep the money completely separate, and don’t think of it as your own. This could stop you from spending money you don’t have, and save you interest and penalties as well as administrative costs in the future. Borrowing from the government could also be the start of a cash-flow death spiral, so stop it before it starts.
Bonus trap for when you’re borrowing to make a purchase - Not matching the nature of the asset with the nature of the financing (using a short-term loan to purchase a long-term asset, or vice versa). Relevant for most businesses, especially those making large purchases.
Short term asset purchases should be made with short term credit, such as credit cards, accounts payable, or a line of credit.
Long term assets, such as a building, a customer list, capital equipment, should be purchased using long term debt, such as a mortgage.
This will line up your expected cash inflow from the asset with your outflow to repay the loan.
If you don't take this approach, you could find yourself running out of money too soon, or having debt that outlasts the corresponding asset.