Even companies, whose products are selling like anything, run out of cash.
Reason is simple: They are spending a lot in getting the product out to market (staff, inventory, manufacturing, marketing, etc.) but the money is taking time coming in, stuck in tough business terms (e.g. distributors may be paying after 60 days), or the online payment gateway has withheld payment while it auditing stuff...there are many reasons for the incoming cash holdup.
Your job is to find the blockage, remove it asap. Or, you make sure these blockages don't happen, and if they do happen, you aren't affected as you have cash in reserves.
This is done via,
- spending wisely (no expensive parties)
- holding payments (staff bonuses, supplier payments - yes, it is ironical, it is business)
- chasing down your receivables
- disposing of inventory etc you don't need, and most importantly,
- constantly looking over the cash flow statements for possible thunderstorms.
Nine numbers that every entrepreneur should know
1. Working capital: Your current assets - your current liabilities
Decrease in working capital means you sales may be declining, and/or expenses increasing.
Increase in working capital may also mean you have excess inventory.
2. Revenues: Total sales.
Track sales growth/decrease every month, keeping mind your overall sales target for the year.
3. Gross profit: Gross revenues - cost of making and delivering your products/services
Most businesses try for revenue being double the cost of production, at least. Declining profit margins means you don't have much control over your costs.
4. Sales per employee: Gross revenues/total number of employee
This is an indicator of how overstaffed you are.
5. Customer acquisition cost: Total cost of sales and marketing in a period/total number of new customers in that period
This number will help you calculate how long it will take you to pay back the cost of acquiring every new customer. Businesses are successful when then get new customers cheaply and are able to keep them for a long time.
6. Quick Ratio/Acid test: Total assets / Total liabilities
This number shows how financially stable you are. Investors/banks focus on this number. Ideally, a business should have more cash available than what it owes. In most industries, the Quick Ratio should be >1.
7. Days sales outstanding (DSO): The average number of days it takes for your customers to pay
Try to have this number as small as possible, meaning you have the cash quicker, which you can use to reinvest in business etc. Experts say an ideal DSO figure is 133% of your payment terms with your customer.
With 'Net 30' terms (30 days after invoicing0, your DSO should ideally be 40.
8. Break-even Point: The point at which your business will make a profit after a sale. For this, you should know your fixed expenses (they do not increase when sales increase: E.g. Rent), and your variable expenses (Expenses that increase when sales increase - costs of material, fees, overtime etc).
Then you first calculate your Contribution Margin:
Contribution margin: Revenues - Variable expenses
Contribution margin per unit: Revenues per unit - Variable expenses per unit
Break-even point In units: Fixed expenses per week /Contribution margin per unit
Desired profit in units (when you also want a profit rather than just break even): (Fixed expenses per week + Your desired profit for the period)/Contribution margin per unit
Break-even point in sales dollars: First, you calculate the contribution margin ratio, which is contribution margin divided by sales (revenues).
Thus, Break-even point in sales dollars: Total fixed expenses/contribution margin ratio.
9. Industry specific magic numbers: E.g. Hotels must have a minimum occupancy % to be viable; restaurants must fill a minimum number of seats every day, and so on.
Thank you for reading.
This guide is from The Success Manual, which contains 200+ guides to succeeding in business, career and personal life. Get the pdf ebook for $12 only.