Cashflow is the lifeblood of any business, but it takes an array of different skills to sustain properly. If you find that idea intimidating, you’re not alone. In fact, over 40 per cent of Australian small business failures are driven by cashflow problems.
To help shine some light on what cashflow is all about, ShortPress spoke to Dr. Dennis Maddern, founder and executive chairman of Maddern Financial Advisers.
The importance of cashflow
“Cashflow”, says Maddern, “Is the ability of the business to meet debts as and when they come to you.”
“There’s an old saying that accountants have: the ‘Holy Trinity.’ You’ve got your profit-loss statement, your balance sheet, and you’ve got cashflow. And the greatest of the Holy Trinity is, in fact, cashflow. You can have a very strong balance sheet – you might even own your premises and equipment and so forth, and you might have a reasonably good profit position… But cashflow is absolutely critical.”
Keeping your finger on the pulse
Maddern stresses the importance of strong bookkeeping. Knowing where your money is going will allow you to monitor the health of the business. Without strong metrics, you’re flying blind. When it comes to cashflow, one of the most important metrics is the “EBIT.”
“EBIT is ‘Earnings Before Interests and Tax,’” he says. “That’s your gross profit, and out of that comes interest and tax. You need to monitor that metric very, very closely. Firms need to know that salaries – and that includes the owner’s salaries – are roughly 40% and general operating expenses are about 30%. And then you’ve got to have a reasonable gross profit as well.
“Your EBIT needs to be around the 30% mark. By the time you’ve payed tax, your net profit position could often be 10% or 15%, so if you think about making a dollar and you’re only walking away with ten or fifteen cents, then that’s very important.”
“It’s very important to be able to make sure that you can manage your creditors well."
Mind the gap
Cashflow is all about timing, and Maddern urges keeping this in mind when invoicing clients.
“In our accounting division,” he says, “We focus on small and medium-sized businesses… And sometimes their credit terms are just too long. If we did accounting work for someone, we would have an invoice for them within seven days. Some firms will have thirty days, and within no time, that thirty days has blown out to forty-five, to sixty, to seventy, to ninety days.
“Of course, for a new, starting up firm, that’s an enormous problem. On paper they’ve got all this money that’s owed to them, but they can’t get it, which means they can’t pay debt as and when it comes due, which means they can’t pay salaries, electricity and so on.
“It’s very important to be able to make sure that you can manage your creditors well and that you have appropriate credit terms.”
Steer clear of the “double helix” trap
This is a fancy term for what happens when sales and marketing don’t line up. It’s a sticky cashflow problem for SMEs in particular because they often struggle to both service clients and generate new business at the same time. The result is a financial rollercoaster that’s anything but fun to ride.
“That happens a lot,” says Maddern. “We have a few web designers as clients which we do the accounting for and absolutely, they will market on LinkedIn, and they will get two or three web designs to do, they’ll end up doing it, they’ll finish the work – and then the basket’s empty again. Then they’ve got to go marketing again, and while they’re marketing they’re not earning, and vice versa.
“These folks have to get comfortable in being able to hire a marketer or something like that, somebody to come in one day a week and do the things that they need to do.”
“Particularly in the early stages, if we have a cashflow problem, we’re finished."
Solid foundations are the key
The point that Maddern keeps coming back to is that successful cashflow is really about rock-solid planning.
“As trite as it may sound, you really do need your business plan in place. You need to make sure you’ve got appropriate [overheads] that aren’t over-the-top, that you’ve got budgets in place, that you’ve got some metrics.
“Particularly in the early stages, if we have a cashflow problem, we’re finished. We have to shut the doors, and our brilliant idea is lost. So again, it’s these fundamentals that make all the difference.”
Joel Svensson is a Melbourne-based freelance writer specialising in politics and business.