Sep
Article by: Jeff Skolnick, CPA, M.S. Taxation
There are a number of factors that can lead to cash flow issues in your business. We’ve all heard the adage “Cash is King” but this can be especially true of your business and even more so in the early years.
I will now address some of the more common cash flow problems that your business may incur with some suggestions to help mitigate these circumstances.
Your company is brand new and you have just commenced operations. First of all, Congratulations! It takes hard work and courage to open your own business and most people are not willing to do the work or lack the confidence to take this step. Here are a few things you must watch out for:
- If you’re in a brick and mortar business you may have to outlay significant cash in order to purchase equipment, inventory, rent retail space or hire employees. There are also the normal operating expenses such as telephone, utilities, advertising, etc.
- In order to fund the above items, you may need to obtain a loan. This is not always so easy for a startup company. There is no track record that you can show a bank and while you will be a guarantor on any loan if you have recently left your job, you may not be as good a risk as you were when you were working full time.
- Whether you are in a brick and mortar business, service business or some other entrepreneurial endeavor, it is almost impossible to generate income on day 1. Let’s say you become a realtor and you sell a house on day 1 (ignore for a second how unlikely this is). If you are lucky enough to sell a house on day 1, you probably will not be paid for almost 2 months. If you are a contractor (let’s say you install flooring) and again you land your first job on the day you open your doors. Many times, as a contractor you will not be paid until the general contractor is paid by his/her customer and again you will have some type of a waiting period.
- Most businesses have periods that are a little slower than other periods. Some businesses have wide swings while others are much more consistent, but you must be ready for a slow month
- Businesses incur unexpected expenses all the time. Equipment can break or expenses may go up suddenly on a product or service essential to your business.
Now that I’ve depressed you with many things that can go wrong in your business, let’s discuss what you can do to help mitigate such situations.
- You can establish a line of credit.
- You can dig into past savings if you’ve ben able to create a little nest egg before you start your business.
- You could borrow money from family and/or friends
- You may use credit cards, although this is generally my least favorite option simply because the interest rates tend to be very high.
It is essential that as soon as practical you are able to set aside enough cash to cover three to six months of expenses. If you are able to do this, you should be able to cover the shortfalls that are almost sure to come in your business.
Borrowing money can lead to other traps that can hurt your cash flow. When you borrow money for your business you do not pay income tax on it. This makes sense because it is not income. The borrowing will certainly help your cash position but when you begin to pay this money back it can hurt your cash position. Let me explain with an example. Your Company borrows $100,000 and let’s say that money is used for deductible business expenses which reduce your income and help your cash flow. So far this is all good, so why am I worried? The issue comes when you pay back the loan. While the interest portion of your debt is a deductible expense the principal portion is not. Let’s say you borrowed the $100,000 in year one of your business and in year two your business generates a $40,000 profit for tax purposes but you use the $40,000 to pay off part of the principal of the debt. The problem occurs because your business has a $40,000 profit with no money available for taxes because it was used to pay off the principal balance of a loan which is not deductible. Proper planning must be done in this scenario to pay down some debt but also leave enough cash available to be able to cover your tax liability.
There are also the obvious ways to help cash flow such as increasing revenue. This is not always as easy as it sounds because this may require advertising dollars which can actually reduce your cash before the benefits eventually start to kick in.
I often hear from business owners that they are not interested in hearing about or reading about taxes or bookkeeping however both ae essential in cash flows. First of all, a proper set of books will make it much easier to identify areas where your Company is spending money in excess of what is necessary. Taxes are important because knowing the rules can help to reduce your tax bill which will in turn allow you to keep more cash in your pocket. I am in no way trying to say that you need to become a CPA, however, I am saying if you are aware of the rules it will enable you to make more informed decisions throughout the year. Tax savings techniques available to businesses after the year has closed are much more limited than those available during the year.
As a business owner you will always be in a position where you are looking to increase revenue, decrease expenses (including taxes) and put more cash in your pocket. I cannot stress enough that it takes planning for all of these things to happen. My goal here is to make you aware that cash flow management is a vital part of managing your business and the better you become at this task, the easier and more stress free your life will become.
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