Summary

The article outlines five critical cash flow traps that business owners must avoid to ensure the sustainability of their operations.

Abstract

The author shares personal insights from their business journey, emphasizing the importance of managing cash flow effectively. The article identifies low gross margins, slow-paying invoices, high overhead expenses, bad debt, and slow investment or capitalization as the primary cash flow traps. Each trap is accompanied by strategies to mitigate its impact, such as differentiating services to justify higher fees, implementing upfront payment requirements, cutting unnecessary overheads, and investing profits back into the business to fuel growth. The author stresses the importance of learning from their mistakes to avoid these common pitfalls and maintain a healthy cash flow.

Opinions

The author believes that competing on value rather than price is crucial for achieving higher gross margins.
They suggest that business owners should not shy away from reminding clients to pay, as this is essential for maintaining cash flow.
Regularly reviewing and reducing overhead expenses is seen as a necessary step to improve cash flow.
Implementing a robust client engagement process is recommended to minimize the risk of bad debt.
The author advocates for reinvesting profits or adding debt strategically to capitalize on business growth opportunities.
A long-term view of the business is considered vital for making informed decisions regarding capitalization and investment.
The author emphasizes the significance of financial education for business owners and promotes their book, "Tax-Efficient Wealth," as a resource for building wealth in a tax-efficient manner.

5 Cash Flow Traps You Must Avoid to Stay in Business

These cash flow traps almost ruined my business…learn from my mistakes

Several years ago when I started a business with my business partner, we faced a number of cash flow challenges as we did not pay close attention to these 5 key drivers of poor cash flow.

“Never take your eyes off the cash flow because it’s the lifeblood of business.” — Sir Richard Branson

If you run a business you will agree that cash is critical to keeping your doors open. As they often say, cash is king!

Here are the 5 key insights I learned from my experience dealing with cash flow issues and the undercapitalization of the business very early on.

1. Low gross margin

Following a close analysis of our margins, we realized that the low margins on our sales were a critical contributor to a lack of sufficient cash flow in the business.

This was primarily due to the low fees we charged early on in the business. In our attempt to quickly acquire clients, we went low on fees and provided services similar to other providers. We essentially competed on price rather than on value.

We could not justify charging a higher fee due to the lack of differentiation in the market place. To address this concern, we now invest in ways to differentiate our services from the rest of the market. We are continually working on different ideas to change service delivery and add more value to our clients.

If you are able to offer more value to your clients, you can charge higher fees for the value you provide — value that clients cannot get from your competitors.

Entrepreneurs believe that profit is what matters most in a new enterprise. But profit is secondary. Cash flow matters most.” — Peter Drucker

2. Slow-paying invoices

At some point in my business, this was a big concern as we had thousands of dollars in receivables that were 30 days, 60 days, and sometimes 90 days past due.

The impact on cash flow can be significant when invoices are not paid on time. For some understandable reasons, we were shy to ask our clients to pay.

Our clients are busy professionals and business owners, so most often they simply forget.

As business owners, it is our responsibility to remind clients to pay. To address this problem, we implemented a few things like:

Requiring upfront payment of a certain percentage of the total fees prior to commencing the engagement;
Invoicing more timely;
Following up more frequently on unpaid invoices;
Offering early payment discounts;
Implementing monthly or quarterly recurring pre-authorized payments; and
Automating the process to remind clients of unpaid invoices.

3. High overhead expenses

Every business will have overhead expenses that must be managed closely. The overhead expenses impacted our cash flows and we found it challenging to cut in this area.

What we did was to look for cheaper ways to pay for the key things we needed. For example, we cut our radio advertisement which was expensive, and spent a fraction of that money on running events and online marketing.

“The more a business owner knows about their cash flow, the more empowered they become.” — Nick Chandi

4. Bad debt

If you’re in a business like ours, you will likely deal with bad debt. While the impact on our cash flows is less for this issue compared to the others, we have had our share of bad debts.

These are clients who just don’t pay part or the entire invoice. Requiring upfront payment has minimized this and implementing a more robust client engagement process is something we are refining to help substantially reduce the likelihood of bad debt.

“If I had to run a company on three measures, those measures would be customer satisfaction, employee satisfaction, and cash flow.” — Jack Welch

https://dwdqz3611m4qq.cloudfront.net/wp_content/uploads/cover-guide-to-cashflow.png?mtime=20190720095122

5. Slow investment or capitalization of the business

A growing business requires capitalization to fuel that growth. You can capitalize one of two ways — reinvest your profits into the business or add debt to the business by borrowing.

In running our business, we’ve used both options but to a limited degree. Although our business has grown over the last couple of years, the growth has been slow, principally because we’ve not been aggressive in throwing more capital to fuel growth.

Growing a business is a double-edged sword. On the one hand, it can put significant pressure on your cash flow. On the other hand, if successfully implemented, it can add a lot of new cash flow streams to your business.

We’re now at a place in our business where we feel comfortable increasing the capitalization of the business a little bit more aggressively than we’ve done in the past.

We continue to minimize owners’ draw from the business so we can leave the capital to invest in growth.

“There is really only one way to address cash flow crunches, and it’s planning so you can prevent them in advance.” — Elaine Pofeldt

The key here is to have a long-term view of your business that will enable you to invest more in the capitalization of the business.

https://www.theprofitkey.co.uk/wp-content/uploads/2015/12/cashflow.jpg

Final Thoughts

It is quite easy to fall into these cash flow traps, particularly if you’re just starting out in business. So, I hope you can learn from my mistakes and avoid these traps in your business.

P.S. I am on a mission to arm you with financial education. That’s one reason I started writing on medium and that’s why I wrote Tax-Efficient Wealth. This book will help you accelerate your wealth in a tax-efficient way. Grab a FREE eBook version of my new book, Tax-Efficient Wealth, to learn how you can build wealth quickly using strategies that will save you a ton in taxes.