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7 Biggest Mistakes Businesses Make With Cash Flow

07 March 2011

They say in business CASH FLOW is KING, but what is cash flow in a business sense? Cash flow refers to the movement of cash into or out of a business, or project, or financial product. I'm also often asked why is cash flow so important and isn't profit more important? Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable. So for that reason, cash flow is KING. In fact the reason why many small businesses go broke is because they grow too quickly and can't fund their expansion. So now we know why cash flow is so important- let's look at the seven biggest mistakes many businesses make when it comes to cash flow.

 

Inadequate monitoring systems. The business owner doesn't know when their cash levels have fallen too low as they don't monitor them often enough. So the first thing they know all their accounts are so far in arrears that they can't refinance or negotiate them into better terms and they risk losing all their security including their own home; where as if they had simply monitored the situation and moved to negotiate earlier they could have saved their home and even their businesses in some cases.

They don't pay attention to their order of debt. Lowest cost of debt first and more costly later. Please see table below( extract from my book www.flirtingwithfinance.com.au)

TYPE OF DEBT

APPROXIMATE RISK PREMIUM

EXPLANATION

Mortgage

Cash rate plus 1%

The bank takes the property as security over the loan. This is considered a secure asset.

The deposit on the loan will vary (sometimes no deposit is needed - see mortgage insurance discussion on page xx)

This rate also applies to owner occupied properties and to investment properties (though investment properties may have a higher risk premium).

A typical mortgage loan term is 25 to 30 years.

Commercial Debt

cash rate plus 1.7%

Commercial loans usually require a 30% deposit and they charge a large \"application fee\" of at least 1%.

These loans are secured over assets of the business, this is referred to as \"commercial security\".

Loan terms are typically up to 15 years for commercial debt.

Secured Personal Loans

cash rate plus 2-3%

Secured personal loans are secured by something other than property.

This could be a car (car loan), shares (margin loan), art, boat or other asset.

Loan establishment fees are typically smaller than for a commercial loan.

Loan terms are usually shorter than mortgage and commercial loans, for example, a typical car loan would be for five years.

Unsecured Personal

cash rate plus 5% or more

Unsecured personal loans are loans that are not tied to any specific asset (hence the name, \"unsecured\").

As well as bank loans, this type of loan includes store cards and offers from furniture and white good stores.

This can be an expensive form of debt and is usually short term, up to two years, and for smaller amounts.

While a standard premium might be 5% above the cash rate, some of these loans can be as high as 25%

This is not the kind of debt people want to have for long as can be very expensive.

Credit cards

0 to 22%

Credit cards are a type of unsecured debt.

They have their own fee and interest structure.

Typically there is an annual fee, an interest free period, a minimum monthly repayment and an interest charge.

The cost of these charges can vary dramatically depending on the terms and conditions of the credit card.

What this table means is that the lower the interest rate of the debt the cheaper the debt is to hold. Currently you can get home loan interest at around 5% and credit card rates, after the introductory period are around 20%, which means a $50,000 credit card debt is the same as a $200,000 mortgage! (If possible always make sure however you check how your debt is structured with your accountant- as sometimes you can't put tax deductible debt against a home.)

Small business owners often don't know all their financing possibilities. They don't realize you can sometimes take cash out of, home, business, equipment, inventory, cars and equipment. Also they don't know how to move cash around quickly; this needs to be arranged when facility is setup. A broker can help you or your banker as well as your accountant in structuring this debt. Recently credit has become more difficult to get for small businesses, so now more than ever people are turning to brokers.

Small business owners often don't speak to their lenders early to find out what flexibility they have as they don't trust them not to pull their loans. There are 2 ways around this, one to have a broker in the middle negotiating for you, or two if you are being relationship managed by a bank, simply ask them what powers they have. Also think about it from the banks current perspective, they don't want to sell you up right now because properties are not getting top prices, so it is in their interest for you to survive if at all possible. At the moment it's a good time to ask for leniency if you know you can get out of a temporary cash flow problem. If they say no now you probably have to sell up anyway.

Small business owners often don't keep spending money for their income producing marketing activities that drive their business. They think they need to save all expenses and are not selective about keeping expenses that drive their businesses. Some don't even know what the return is for their various marketing activities ie their return on equity(ROI) - the return for dollar spent. A simple email newsletter is one inexpensive way to keep you top of mind with customers and often over looked and also has one of the biggest ROI's of anything you can do. A good book for other activities is Brad Sugars \"Instant Cashflow\"

Small business owners often don't know the tax consequences of the way they structure their debt. Whether you are a sole trader, or partnership or company changes the ways you have your tax arrangements. A simple visit to a good accountant can fix this up, be sure to get an accountant who specializes in your type of small business. My book www.flirtingwithfinance has a section on how to pick an accountant under Little black book.

Small business owners often have no worst case exit strategy; if they simply had a strategy they would know when to hold and when to sell. There are some good stories from the books \"The Dip\" and \"Who Moved My Cheese\" about simple strategies. You need to know what are the indicators that you just can't improve from? What are some indicators that you can turn around from? Or as my friend Greg says \"you gotta know when to hold them and when to fold them\". It will change with industry to industry but you need to decide what's right for you in advance. Also there is the dignity issue where a lot of people know their business is going no where but feel too proud to leave, it shows greater strength of character to gracefully leave a no win situation, which can happen to anyone, and you can learn from, than to continue to keep your head in the sand thinking you are saving face, quietly losing all your assets as well as your business.

IN SUMMARY FOR CASHFLOW TO WORK: MUST KNOWS

Must know income. Sales (daily, monthly, quarterly - depending on size of business to how detailed you go.

Must know likely future income.

Must know ROI ie conversion for cost of marketing.

Must know expenses -broken down into Monthly and then a monthly breakeven figure to work it out.

Must know /have in place possible deals with suppliers, inventory financing, case etc if needed.

Must know order of debt cost. See above chart

Must know tax consequences of your spending/order/structure (consult accountant and broker when setting up debt)

Must know your worst case scenario.

Change your system and you could end up with the best case scenario!

 

By Virginia Graham a finance broker from www.modelmortgages.com.au

 

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1 comments

  • redrock brokers

    redrock brokers 5 years ago

    Most probably every finance related person make these common mistakes.