Profits, Growth and Cash Flow – Which is Most Important to Small Business Success?

Business growth and profitability. Most entrepreneurs would consider these to be the Holy Grail of business ownership. So it’s not too surprising that many participants in the financial workshops I lead are surprised when I tell them that instant profits and rapid business growth aren’t always a cause for celebration.

“How can this be?” you might be wondering. The best way to explain it is to tell the story of the Wonder Widget Company. Haven’t heard of them? Well, this is a fictitious company I made up to help me explain business financial concepts in an easy-to-understand way.

A Hot New Launch

Wonder Widget Co. launched last year with $100,000 in cash and the hottest new product in its market, the amazing Wonder Widget. It was so hot that the owners had sales and profits the very first month of operations. So they quickly leased and outfitted a factory, production equipment and furnishings (all with minimal initial cash outlay), bought materials, hired workers, and manufactured and shipped widgets. Then they mailed invoices totaling $50,000 to customers in the first month. Amazing!

They paid their bills as they came due and collected from customers in the normal course of doing business. Meanwhile, sales continued to grow, increasing by $50,000 every month with no decline in margins and no serious competition, and profits climbed without a pause.

But a strange thing happened on the way to the bank: The owners were shocked to find that they didn’t have enough cash to pay their bills. Soon, they couldn’t buy any more raw materials to manufacture Wonder Widgets or make their payroll. Instantly profitable Wonder Widget Co. was insolvent six months after they opened the doors.

On the surface, it’s hard to see how something like this could happen to a profitable and growing business. But when you dig a little deeper, it becomes clear that there’s a whole lot more to running a successful business than just profits and growth-namely, cash flow.

The Cash Flow Cycle

Understanding what happened to Wonder Widget Co. starts by understanding what’s known as the cash flow cycle. This is the time lag that exists between when cash is paid out by the business for things like equipment, raw materials and salaries and when accounts receivable are collected. In manufacturing, the cycle usually consists of converting cash into raw materials, finished goods, receivables, and then back to cash again.

At the beginning of the cash flow cycle, nearly every business starts out with-you guessed it-cash. But from that point on, the central purpose of the business is to convert that cash into other kinds of assets or to leverage or extend it with liabilities, and ultimately to turn it back into cash again-but this time, more cash than the business started with. This process continues indefinitely and simultaneously throughout the life of a business.

When the company started up, its first activities revolved around setup-renting facilities, getting phones and utilities installed, etc. At the same time, it was purchasing assets so it could start operations. These included office equipment, computers and the like. Of course, the company also needed employees to answer phones, run the office, and produce and sell Wonder Widgets. The owners financed some of these costs, but obtained credit via bank loans to cover most of them.

With all this in place, the company was ready to begin production, or the manufacture of Wonder Widgets. Unfortunately, the process consumed even more cash: wages, taxes, sales and marketing, more raw materials, and so on. In fact, this is the period of greatest cash consumption for most companies, as they are in full production mode but no cash is coming in yet.

Finally, Wonder Widgets was ready to sell its products and begin the process of recovering all the cash it has been spending (or investing) in the business. However, while sales were brisk, they were made on “net-30” day terms, which means the company won’t actually receive cash from these sales for another 30 to 45 days, at least.

To add to the challenge, growing sales means the company had to buy more raw materials than they did the first time around. Since they were selling more each month than the prior month, they needed to not only replace inventories consumed but also buy additional goods to satisfy their growing sales demand. Purchases can actually exceed sales in such a fast-growing environment.

Collections are the final step in the process. While this might seem like a minor activity in comparison to production or sales, it’s actually the most critical task in making every other step pay off. Unfortunately, it’s the step that many businesses, including Wonder Widgets, neglect-and that leads to their ultimate demise.

Don’t Give It Away

Are you starting to see how Wonder Widgets failed despite having strong profits and sales right out of the gate? Nolan Bushnell, the founder of Atari and Chuck E. Cheese Restaurants, put it this way: A sale is a gift to the customer until the money is in the bank. This final step is the one that turns the entire effort-setup, purchasing assets, hiring employees, obtaining credit, and producing and selling products-back into cash again.

At this point, the answers to some important questions will begin to surface, like: Did the company ultimately make a profit on its business activities? Did it plan adequately for the working capital it would need to finance the cash flow cycle in it’s entirety? As the Wonder Widget story makes clear, answering “yes” to just the first question isn’t enough to ensure business survival. There are three key takeaways from this story:

1. Fast growth is a double-edge sword. Fast-growing companies need more working capital than those growing more slowly or not at all. When incoming cash flow is delayed while fixed costs continue and paydays come every week, there’s a limit to how long a company can operate comfortably, even if it’s profitable.

2. Cash flow needs must be forecasted months in advance. This is especially critical during the early months of a startup. And cash flow results must be tracked separately from profits.

3. Business goes with the flow. The health of a business depends on the health of its cash flow. As Wonder Widget Co. makes clear, more businesses fail due to a lack of cash flow than a lack of profits.

Focus! Your Business Depends On It

As an entrepreneur you have to wear multiple hats. Some days the positions can range from Researcher, Webmaster, Accountant, Inventory Manager, Distribution Manager, Customer Services Representative, Sales Manager, and on and on. All these hats can make it hard to complete tasks and focus.

One way I try to stay on track is creating a daily list of goals. For some strange reason some days I spend more time on one task and less (or none) on others.

One particular day I was asked “How long do you spend on a task like research?”

Well, that’s a good question but I followed it up with a bad answer, “until I am done”.

This was a bad answer because there was no time frame attached. Though I had many tasks on my list that day, I spent the better part of the day researching (basically surfing the net from one site to another) neglecting the other tasks on my list.

I had to find a way to focus. To make sure I was only spending a set amount of time on each activity. To complete all the tasks on my list otherwise my business would suffer.

After all what was the point of setting my daily goals if I could not stay focused?

To aid in my quest to focus my attention I needed to automate my daily list of goals then limit and track how long I was spending on each task.

For this I turned to Yahoo! Widgets. Yahoo! Widgets is a free application platform for Mac OS X and Microsoft Windows. These Widgets help you save time with an at-a-glance view of your favorite Internet services right to your desktop. Be careful you can loose focus just searching through the Yahoo! Widget Gallery because they offer over 4,000 desktop Widgets that do almost anything from displaying a weather forecast to playing a game.

Widgets generally sit on your desktop and don’t look like applications as we’re use to seeing them in a standard window. Instead, Widgets tend to look like small pictures or animations.

Here are four Yahoo! Widgets I used to boost my focus:

1. JC Sticky Deluxe

This Widget is just like any sticky note / post-it note / memo taker. It has a ton of cool and powerful features like; multiple stickies, customizable fonts, colors, background themes and the ability to print stickies.

2. Job Timer

This Widget counts up instead of down. It is useful for timing how long a job, presentation, or any other task takes. You can name your task so you can actually time 5 simultaneous tasks at once.

3. Generic Countdown Timer

This Widget is a simple countdown timer. You can set the time in hours, minutes, seconds and an alarm will ring once the counter reaches zero. You can choose to initialize the counter with a default time when the Widget starts, which is convenient when you always need a countdown for the same amount of time.

4. DailyBilling

This Widget is a time tracker for sorting and accumulating time spent on projects. Multiple projects and multiple hours may be tracked each day. Data is written to a file each day that can be referred to at the end of the week when you compile your time and can’t remember what projects you worked on last Tuesday.

By using technology more effectively, you will get more done and stay focused. Your business depends on it!

Dreaming of Owning an Online Business

Everyone dreams of having his or her own business from the very small to the multimillion versions. Dreams are of course free to anyone. When a dream becomes a reality, there are lessons to be learnt that will help expand or destroy the business.

Depending on a sole supplier for your business widgets could be a fatal mistake if they go out of business and you have not acquired other contacts. The question that you need to ask is whether you would be able to continue with your business if the supplier collapses and how you would tackle the situation.

Businesses grow from interacting with other businesses. Today it is called networking, whether it is done on line or physically over a coffee it is an essential part of the business world. Take time to get to know others and note how they run their business.

If your business is not showing the increase you had planned on, step back, and have the courage to change the current model you have. It is often said that succeeding requires a certain amount of risk, and that risk takers are the ones that succeed.

Your business website may not be all that it should be if the URL you are using is part of the problem. Does it suit your business and have the keyword essential to attracting the customer. A business with no customers will never be a business. The saying ‘fails to plan, and you plan to fail’ is actually a good one. A real business requires a business plan and by default a marketing plan. This puts processes in place to maintain and improve your business, be it an online one or a bricks and mortar establishment.

The much used Strength, Weaknesses, Opportunity, and Threats analysis is a good place to start. When you have a business today marketing becomes extremely important and time needs to be spent everyday nurturing your network, your website, or your customers. There will come a time that the business is on the bones of its backside and all of a sudden, there is no money coming in. It is too late at that point to start realizing the lost opportunities of marketing.

Staying in touch with people on a regular basis creates trust and a well run website can do just that for a firm that takes its customers seriously. We cannot assume that people will stay with a company because the owner thinks they should. ‘Assume ‘makes an ass-of -u-and -me. Trusting people is not without its own risks and others whose perspective is different from our own will have hurt us all. Take the chance, grab your own website and start planning to make your dream a reality.