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Day 14: Consider Cash Flow

Today's Prompt:

Main point: Cash flow is the biggest killer of small businesses.
Solution: Use this prompt, and conduct additional research, to understand different types of revenue structure, and aim early on to build in recurring revenue.

One of the main reasons that small businesses and new ventures fail is cash flow.

Today, we're going to discuss why this is such a problem and what practical steps you can take to make sure it's not an issue for you. By making a few decisions now and setting up simple systems, you can make managing cash flow a lot easier. We'll focus on some practical ways to save you from future headaches.

First, let's make sure we are all on the same page about the definition of cash flow. Cash flow is a fancy way to describe how much money you are making and how much money you are spending and, perhaps more importantly, when you are making money and when you are spending it. It's the timing of these incomings and outgoings, and the failure to manage them, that scuppers a lot of early-stage businesses.

Let's say you made £1,000 in sales coming this month. Great! Pop the champagne! 

But wait. When is that cash arriving? How long passes between delivering a service/product to a customer and getting the cash? This is generally not a problem if you are selling goods in a shop or a service that is delivered immediately (like a haircut). Customers come in, get their hair cut, pay, and leave. Simple.

If you are selling a product or service to a large company, then you might find they operate on a 30-, 60-, or even 90-day payment period. This means you deliver the goods or services, and you may not get the cash for another couple of months. This is normally the same if you are a craftsman or creative – you'll generally begin production before receiving all the money. 

So, let's go back to that £1,000 on its way to you. Imagine it won't be due for another 60 days. You're suddenly in a sticky situation. You might need that cash to pay for materials to deliver the goods. How can you build the client's new desk now without buying the materials? You'll need to use money from a previous gig (now in your account) or borrow the cash. 

Normally, doing either of these (dipping into savings or borrowing) works, but sometimes, you'll get caught with more going out than coming in. If you can't afford to keep the doors open, or to buy the materials you need to produce your work, then your future incoming cash is in jeopardy.

This situation may sound daunting, but it is avoidable if you set up your business using processes. We’ll run through several methods that can help you avoid cash flow problems and scale up more gracefully. Not all will be applicable to your business, depending on your market and what you provide, but hopefully, some suggestions will be useful.

First, and perhaps simplest, get paid up front! This is the easiest way to make sure cash flow is not an issue. Collect the revenue from sales before accumulating any costs connected to the creation of that revenue. 

This is easiest in digital-only businesses where you don't need inventory, storage, physical production, or any of the other downsides of physical goods. This is the appeal of a lot of online goods, especially purely digital.

Or say you manage a catering company – it is easier to set up expectations with your clients that they pay prior to the event that you’re catering so you can use their payments to cover your costs. If there is a way to collect all the cash up front before spending any money on delivering the product/service, then happy days!

Second, use installment payments. Let's say that your product or service needs to be created from scratch each time, and it's not plausible to collect all the money up front. For instance, a film maker making a promotional video for a company – most likely, your client will not give you 100% of your fee up front but, instead, will want to see some evidence that i) you've done the work and ii) it's up to standard before they hand over the full amount. This makes sense as, otherwise, you could collect your check and disappear – it's too much risk for the company or person that hired you.

But because of the costs of production, you don't want to be paying for everything up front and then waiting until after you’ve shot all of your footage, edited the content, and produced the final film and delivered it before you receive any payment. That's too much risk for you.

In situations like this, some form of split payment is an obvious solution; 50% up front and 50% on final delivery will work in most cases, but for more complicated projects, further instalments may be required. 

Third, look at some form of automatic subscription. Subscription revenue is fantastic. It keeps ticking in each month, on the same day of each month. This keeps your revenues predictable and smooth vs. selling individual, tailored products each month.

Subscriptions aren't only for newspapers and Netflix. They’re relevant in a wide range of industries. Perhaps the broadest "subscription" is a retainer for your services. Let's say you are an expert in a certain field, and someone wants to be able to ask you for advice or for an agreed-upon amount of work each month. A retainer is a wonderful way to set up a recurring revenue stream for you. It doesn't even have to be large – it could be £20/month from a neighbor to come and fix their computer when it stops working. Or if you’re a baker, you can set up a subscription fee for your baked goods to be delivered to cafes in your area. This ensures that you won’t be chasing people for your cash.

There are some great tools out there to help you manage your cash flow and, ideally, set up subscriptions. New companies and online banks are popping up and facilitating small businesses and sole traders in opening bank accounts quickly instead of going to a traditional main street bank and waiting ages for your account.