At a recent seminar I attended for business owners, an attendee asked the presenter…
“How do I know if I am bleeding?”
It was a great question, but the answer given did not do justice to the quality of the question in my opinion.
So I’ve decided to choose this topic as our first blog post subject.
As a business owner, have you ever asked yourself this question? Or spent nights worrying about where your cash flow was going?
In this blog, I’m going to share the tools we use to help you safeguard your business from becoming a victim of cash flow ‘bleeding’.
The question referred to “financial bleeding”. The language used by the person asking the question implies pain, which in our experience, comes from cash flow wastage.
At a high level, the pain of cash flow bleeding is the downstream issue resulting from the issues not being caught and fixed earlier. Think about it as water leaking from a pipe. The earlier it’s caught, the less water leaks out.
Financial bleeding is exactly the same concept.
“How do you know if you are really bleeding?” and “Do you need to go to emergency, or do you need a band aid and get on with it?”
To be successful in business, bleeding should not come as a surprise, months or worse, years after it started. It should be a measured outcome of a plan that didn’t work in the real world.
And if financial bleeding is underperformance in the real world when measured against the goals of your business, the real question is…
“When should you take action to stop bleeding cash?”
First thing’s first, it’s crucial to acknowledge that ‘bleeding’ is a relative term.
If you are trying to measure bleeding, what do you measure it against?
Some form of bleeding is almost impossible to prevent in a growing business, as a business expands it will have some “inefficiencies” in spending. This is a form of bleeding, however it could be a matter of $50 per month. To stop the real bleeding, it’s important to stop the biggest bleeds first, therefore there must be a measurement to be precise about what the biggest bleeds are. Without a measurement people tend to react to the bleeds that annoy them the most i.e. spending days tackling a bleed of $50 per month, ignoring a bleed that is thousands (or more) of dollars per month.
The most meaningful measurement is against the goals set for your business. Bleeding can also be measured against historical performance, however this tends to be more reactionary to what has happened, rather than proactive management towards the outcomes you are seeking to achieve.
Most business owners know the problems in their business.
It’s important to get clear on two things:
- Quantifications: For example, the amount (the exact amount of money or time being “wasted”).
- Causes: For example, the source of the problem (what actually caused the problem in the first place).
The challenge is that without the above, people generally react to the things they can see or that annoy them most. Resulting in not tackling the biggest bleeds first.
Here’s the truth…
Cash flow bleeding is the symptom, not the cause.
For the bleeding to be fixed, the cause must be chased to the source.
So, how do you find the source?
Here’s the steps to follow to get started.
Step One: Set goals as a “5 Year Plan”, then commit to your budget for the first year
We recommend a 5 year “strategic” plan that gives everyone in your business the clarity around what is important and why. It may not have exact measurements, numbers and milestones. However, a 5 year strategic plan should clearly set the direction for the business.
Start by thinking about where you want your business to be in 12 months time. Then, move to what measurements (outputs) you think accurately reflect these goals and are reasonable. Next, move to what investments (time and money generally) you need to make in order to make the outputs (goals) achievable. Check in that the 12 month budget fits the direction of your 5 year “strategic plan”.
Budgeting is often viewed as a dark art or something that accountants practise together in dark places you can only access with a secret handshake – the truth is far simpler and less mysterious than that.
Budgeting is simply turning goals into numbers that are linked to the costs required to deliver those goals. Think of it as an investment made in the expectation of gaining a return greater than the investment.
Using SMART (Specific, Measurable, Achievable, Relevant, and Time-Bound) principles will help you set a budget you can achieve, rather than a dream you hope to achieve.
Remember, budgets are set before the year starts (although, budgets can be set, altered during the year, our advice is to think about the budget before the year starts). A lot can change in a short time frame in business. Clearly understanding your business goals will help you react appropriately when the real world steps in.
Make sure you’re always realistic and invest, don’t gamble. If you are new to goal setting, don’t be overwhelmed – just have a go. Ask someone you trust to play the “Critical Friend” to help you find the holes early, it’s much cheaper this way.
Step Two: Set yearly goals via zero-based budgeting
Next, you should aim to set an annual budget for each financial year. Be patient, until you are familiar with the process, it may take a couple of passes to get fully comfortable with budgeting. Give yourself some time to have a think about the priorities, timelines, investment required and give yourself some time to gather as much information as practical.
Consider the 4 key areas of a profit & loss:
- Revenue – the total amount of sales revenue
- Gross Profit – The profit after paying for direct materials & labour
- Operating Expenses – The “overhead expenses” of the business
- Net Profit – The amount of profit available to the owners
This should be broken into months to reflect seasonal patterns. For example, there are times where doing the work is key and then there will be other times where finding ways to do the work better is key. It’s important to know the difference.
When setting the budget for the year ahead, we suggest a zero-based approach to small business.
What is a zero-based budget? I thought you’d never ask. (And no, it’s not accounting speak).
Unlike traditional budgeting methods that rely on historical spending patterns, zero-based budgeting prompts a fresh start each year. For growing businesses, the needs will change (at least) every year, hence taking a fresh start to realising the goals for the year ahead are important.
A zero-based budgeting approach aims to remove expenditure that doesn’t contribute to your business goals. For growing businesses, this is key, as it allows you to invest the required cash in the areas that will be most likely to return you the goals (budget) set for the year ahead. This process gives you the ability to consider ROI more broadly and think about how to bring your 5 year “strategic” plan to reality through the money you’re spending to get there.
Any expenses that are not required to achieve your business goals should be eliminated from the budget to prevent future bleeding before it starts. Too many businesses invest without redeploying their existing budget to full effect. Hence bleeding becomes an accepted “normal” that is ignored until it becomes too painful to ignore.
This approach compels you to justify every expense from the ground up and fosters an understanding of where each dollar goes and what that dollar brings back.
Preventing bleeding, rather than having to stop it.
As your business grows, it needs to change and evolve, as do its spending patterns. Some expenses should not increase with revenue, whilst some may increase more than revenue growth which allows these expenses to stay fixed in the future.
Zero-based budgeting offers a dynamic and practical way to review the expenses being incurred by your business, not just as numbers, but once again chasing them back to source whilst allowing you to ask: Are we getting ROI on this spend? If not- what can we do to fix it? The earlier the better.
Once you have completed the Zero-based budget, you will have clearly defined the goals for the year ahead and set the expectation of what is required to deliver them. Next step is to ensure everyone responsible for delivering them is aware of these goals and expectations. Clear communication is critical to ensure everyone is pulling in the same direction to achieve the common definition of success.
Step Three: Measure your results against budgeted results
By now, your budgets will be based on the results you want to achieve.
Periodically measuring your actual results against your budgeted results will give you the quantification you need to find the bleeding, isolate it to a specific item, and identify ways to get your business back on budget. Micro-corrections early are more effective than major rebuilds.
Go through this exercise (budgeted results vs. actual results) thoroughly and frequently to get familiar with the numbers of the business. These numbers will show the results of the decisions that have (or have not) been made.
As a business owner, aim to get a deeper understanding of the numbers that relate to the activities of the business. Invest some time converting your business activities to numbers, for example – jobs per week required to get to the revenue goal. The objective is to quantify the variances in what is happening in the real world versus what was planned as quickly and accurately as possible.
Our advice is to go through this line by line and then step back and have a look at the big picture? What are you seeing clearly? Can you relate the numbers back to activities?
Step Four: Analyse your results to get to the cause of your cash flow challenges
Very few business issues are caused by a single factor. As your business expands, causes are often interrelated.
Chasing issues to source is a skill that is learned over time with good quality practice. The more frequently you do this exercise (properly) the better you will get at it. Seek out help from experienced professionals if you’d like to accelerate your learning in this space.
Getting familiar and comfortable with your business finances inside and out is the key here.
The aim of this blog is to give you the practical keys in plain English that we use to chase issues to the source for our clients. Unfortunately, there isn’t enough room on this page to teach you the decades of experience we have.
But we hope you’ve got the practical steps to make a great start…
Now you have measurements and you’ve had a think about the picture it is presenting, can you link variances together?
For example, let’s say revenue from a given activity is currently 5% behind budget. However, the expenses for that activity are 6% below budget.
In the above example, are you really bleeding cash? Or, is this just timing and will align down the track? Are the assumptions you made in budget setting being achieved? Were the assumptions accurate? What micro-adjustments can be made? Keep asking questions until you can answer the questions confidently.
Whether it involves achieving revenue targets, maintaining specific margins, or strategically investing in growth and measuring the ROI from certain activities, we recommend a hypothesis approach.
Increasing debt levels and restricting cash flow are a common signal of financial bleed. While leveraging debt for growth can be valuable, an unchecked increase in debt can lead to a significantly restricted future.
Monitoring the debt-to-equity ratio will help you maintain cash flow and the vital signs of the business. We’ll save that for another blog post – keep an eye out for one about balance sheet management.
Here’s another example…
Let’s say we have underperformed on gross profit margin by 8%. This is equal to $100,000. We believe (our hypothesis) this is caused by:
- Cost of materials increase – Materials cost bleed
- Labour efficiency – Labour efficiency bleed
- Charge rates – Charge rate bleed
Now, we’d break each one down to identify any possible cause and effect.
- Cost of materials increase: Check to see if materials prices have increased more than your revenue. What was the budgeted increase?
- Labour efficiency: Check the actual to budgeted number of jobs being completed. Are the budgeted number of jobs being completed every week/month?
Charge rates: Have all budgeted changes to charge rates been maintained? You may be surprised how often this obvious one gets missed. Hint – often caused by unclear communication & lack of oversight in quoting, tendering.
How to tackle cash flow bleeding
Tackle the biggest bleeds first.
Once you have the key items in your budget (plan) being measured and cause(s) identified, you can start to plan how to tackle the bleeding. By this stage, you should have the core internal factors at hand. Next, it’s time to check your internal factors against external factors.
Here are some possible causes of financial bleeding and some ideas on how to tackle them:
- Cost of materials increase – Invite your key supplier(s) to discuss how they may be able to offer better pricing. Don’t be hesitant to ask the question, remember – they want more of your business. Shop around for benchmark prices, it may not be wise to drop quality and price. The idea here is to maintain quality and reduce price.
- Labour efficiency – Would some overtime be welcomed by the team to gain an extra job per week that creates a win-win for all? Leaving jobs that “only need an hour” the next day will leave the business paying for additional travel time. The more that can be completed in a day, the better the next day will be.
- Charge rates – Are you charging market rates? Are you at least keeping up with inflation (CPI)? Do some research, call competitors (mystery shop) and get some quotes if you need to.
For example, if you do two jobs per day at $1,500 per job, your revenue is $3,000 and your staff costs are fixed at $2,000. This leaves you with $1,000 for materials and profit.
Now, if you can do three jobs in a day the numbers improve to $4,500 revenue with a fixed labour cost of $2,000, this leaves you $2,500 for materials, overtime and profit. See the win-win?
Using the example above, the next question to the team becomes, “What is stopping us from doing 3 jobs per day?”
Hint: Productivity/efficiency is the first major hurdle most growing businesses need to overcome. Streamlining operational efficiencies will help reduce the overall cost per hour of your business and prevent the risk of major future bleeding.
And this is just the beginning.
There are so many other places to look for improvements and prevent future bleeding.
To find these opportunities, we recommend a professional review of your business, financial statements, cash flow patterns, and operational structure.
Key Performance Indicators (KPIs) can become diagnostic tools that offer insights into the overall health of your business in advance, however that’s another whole article. Please let us know if you’d like to learn about KPIs.
If you’re struggling, getting the right help from the right people can stop you from chasing shadows.
Conclusion
The better the facts and understanding you can establish, the better the chances you will stem the bleeding and get your business moving towards its goals.
This process gets easier (and even more enjoyable!) when you commit to the care of your business and prevent it from unnecessary bleeding in the future.
Business is a dynamic state and staying across the relevant market factors will help you see further into the future.
Remember, bleeding may not be just about saving costs. It may be about spending a little more to get a lot more ROI.
Preventing bleeding is all about maximising ROI by minimising waste.
Need any help figuring out whether your business is bleeding financially?
At RDA, we continue to play an active role in our client’s lives, including planning to avoid the bleed, pinpointing the cause(s) and stopping future financial bleeds.
If you can relate to the frustrations of financial bleeding, or want strategic accounting support tailored to your definition of success, we’d love to hear from you.
