Cash is king, they say. In the world of business, truer words have seldom been spoken. Managing your cash flow effectively is crucial for the survival and growth of your business. A well-thought-out cash flow system not only ensures that you always have enough money to pay your bills but also provides you with the financial insight to make strategic decisions. This blog post aims to guide you through setting up a foolproof cash flow system by utilizing separate bank accounts, careful budgeting, and strategic allocation of funds.
But first….
Why Do You Need a Cash Flow System?
If you are a business owner, you know that terms like “bankruptcy” and “liquidation” are commonly discussed. Often, these situations arise due to inadequate cash management. Let me share some of my own experiences with you.
I’ve reached a stage where I oversee several successful enterprises, some of which are valued in the multi-figure range. These businesses are set up to run autonomously, generating revenue even when I’m not actively involved.
However, my journey wasn’t always smooth sailing. Over my three decades in business, I’ve faced bankruptcy twice. It’s undoubtedly a difficult experience, not just financially, but emotionally too. Yet, it’s crucial to understand what leads to such circumstances, so you can learn how to steer clear of them.
Most people don’t start a business with the thought that they might go bankrupt. However, it’s a significant risk factor that comes into play as you launch your entrepreneurial venture. When bankruptcy hits, you essentially lose control of your financial assets, which can be quite a blow to your self-confidence.
In retrospect, those trying times were perhaps necessary for my growth. I gleaned invaluable insights that led me to:
- Reevaluate and adjust my business strategies.
- Implement safeguards to minimize future risks.
One mechanism that I established was to create separate bank accounts.
The Importance of Separate Bank Accounts
Building a structured financial setup starts with segregating your revenue from your expenditures. Think about opening two separate bank accounts to achieve this objective. One account should be designated for your income, acting as a pool that accumulates funds each time you secure a sale or payment. The other account should be reserved for expenses, which you’ll use for settling business-related bills.I talked more about the importance of separate bank accounts in this video:
Example
For example, imagine you own a small coffee shop. In the beginning, you might use your personal bank account for both your shop’s income and expenses, which can make tracking financial performance confusing.
To streamline this, consider opening two separate business bank accounts:
Revenue Account:
All the sales from your coffee shop go directly into this account, giving you a transparent view of your business income.
Expense Account:
You use this account to handle all operational costs, such as supplies, rent, and employee wages. Transfer funds from the revenue account to cover these expenses as needed.
By maintaining these separate accounts, you can easily monitor your coffee shop’s financial health, making budgeting and tax preparation far simpler.
The Magic of Spreadsheets
In addition to having individual bank accounts, it’s beneficial to maintain a comprehensive spreadsheet that monitors all financial transactions. Using tools like Microsoft Excel or Google Sheets, you can easily manage your finances through their advanced features. In this spreadsheet, it’s crucial to have distinct categories for various expenses such as GST, taxes, cost of goods sold, marketing and promotion, general liability, improvements, and financial reserves.
By consistently updating this financial spreadsheet, you’ll stay informed about your current financial status. This practice will also aid in spotting financial trends, forecasting future cash flows, and potentially identifying any financial pitfalls before they escalate into larger issues.
Example
For instance, you can create a Google Sheet where you allocate different tabs for each expense category. Every week, you input the amounts spent in each category. Over time, you can use features like graphs and pivot tables to analyze spending trends. If you notice that your marketing expenses are skyrocketing but revenue isn’t increasing proportionately, you can take corrective action before the imbalance affects your bottom line.
Weekly Allocation: Budgeting Made Easy
After you’ve set up the basics, the next step is to divide up your income into different expense accounts. Depending on your budget and what your business specifically needs, you’ll want to move a certain percentage of your weekly corrected gross income (CGI) into these expense accounts.
Example
Imagine your business pulls in a CGI of $100,000 per week. Here’s how you could allocate the money:
GST: 10% ($10,000)
Tax: 20% ($20,000)
Cost of Goods: 50% ($50,000)
Marketing/Promotion: 10% ($10,000)
General Liability: 5% ($5,000)
Improvement: 5% ($5,000)
Reserves: 5% ($5,000)
This leaves you with $10,000 to either pay yourself or reinvest in your business.
The Perks of a Solid Cash Flow System
Always Having Enough Cash on Hand
Knowing you’ve set aside money for all expected expenses takes away the last-minute panic of paying bills. Sure, people would say that “cash is king.” But I’d argue, “cash on hand is the real king.” It’s usually when you’re in a tight spot that getting hold of quick cash becomes a struggle. That kind of stress can lead to bad financial choices, like taking out a loan with sky-high interest rates because there’s no other option.
With this approach, you can easily see how much money you’ve got on hand at any given moment. So, if your dream scenario involves you kicking back on a beach most of the time, this system lets you quickly gauge how financially healthy your business is. That means less stress and more financial confidence for you.
Here’s how it works in layman’s terms: Ask yourself, if you were to shut down your business today, how much cash would you actually have left? For this, pretend that anyone who owes you money won’t pay you back.
The only real assets you have are:
Cash-On-Hand: This is the money in your bank accounts and any you can easily access.
Bills: This is the money you owe, including things like GST and sales tax.
By keeping tabs on these two things, you’ll have a clear picture of where you stand financially at all times.
Making Informed Financial Decisions
Having informed financial decisions is one of the perks of having a solid cash flow system because it gives you a clear understanding of your financial situation. This information is essential for making sound financial decisions, such as:
Investing in new opportunities: When you know how much cash you have available and how much you expect to generate in the future, you can make more informed decisions about investing in new opportunities. For example, you may be able to identify new markets to expand into or new products to develop.
Managing debt: A solid cash flow system can help you manage debt more effectively. By knowing how much cash you have available and when your debt payments are due, you can avoid defaulting on your loans. You may also be able to negotiate lower interest rates or more favorable repayment terms with your lenders.
Identification of cash flow: By tracking your cash flow closely, you can identify potential problems early on and take action to prevent them from becoming major issues. For example, if you notice that your expenses are starting to exceed your income, you can make adjustments to your budget or find ways to increase your revenue.
Planning for the future: A solid cash flow system can help you plan for the future, such as saving for retirement or buying a home. By knowing how much money you need to save each month, you can create a realistic budget and financial plan.
Overall, having a solid cash flow system is essential for making informed financial decisions and managing your finances effectively. By knowing exactly where your money is going and having a structured system to manage it, you can set yourself up for financial success.
Growing your Business Efficiently
Having a clear financial plan aids in efficient business growth. If not, you might risk doing a “premature scaling.” This is that state where you use or reinvest the money before you can use it productively.
Without any solid plans for the business, it’s easy to burn the cash and end up in a worse situation than when you were starting. Other than being a big waste of funds and capital, this is a huge threat to your cash flow.
Final Words
A cash flow system isn’t just an optional tool for business management; it’s essential for financial sustainability. By setting up dedicated bank accounts, employing a tracking spreadsheet, and allocating funds wisely, you set your business on a path to not just survive, but thrive. Implementing this structure allows you to always have a clear financial picture, make better decisions, catch problems early, and grow your business more efficiently.
So don’t wait. Set up your cash flow system today and take control of your financial future.
If you want to know how I more how I built my cash flow system that allowed me to live the life that I wanted, sign up to my newsletter: https://idealbusiness.invizbiz.com/newsletter