The article was originally published on MarketingiBiznes.pl in January 2019 by Michał Bąk in Polish.

Finances are the bloodstream of every company. When there is no cash flow, the body simply dies. I would like to invite you to read my article and think along how we can heal the finances of your company. Ready?

I could answer with a song by Kękę “Never go beyond means”, but instead I will guide you through the process and tell you how I manage finances in my own company. I will explain when I invest and when I scrimp. I will explain what is a financial cushion, why you should have one, and why you should think twice before borrowing money.

Managing your finances. The factors that you need to consider

Money is the blood of your company. When it stops flowing, the company quickly ceases to exist. To better understand your company’s blood flow we should know what affects the finances of business operations. These factors include:

  • cash inflow from customers – all the money that gets to your account,
  • fixed costs (telephones, office space, employee salaries) – these are “the most pleasant” costs, because if we write them down, we have 100% control over them. So there is no surprises. Salaries are generally fixed, the subscription plan of your mobile phone operator is too. The majority of fixed payments, in addition to their recurring nature, e.g. monthly or weekly invoicing, are also characterized by a repetitive amount – and such recurring expenses are the easiest to control
  • liabilities – all kinds of debts that we have to pay back, such as loans, installments, leasing (I treat them in a slightly different way than fixed costs, although I could put most of these in the point above)
  • unpredictable costs – unfortunately this is the worst and probably the most stressful of all expenses, mainly because they cannot be planned at the beginning of the year or at any other stage of planning. The only effective defense in this case is your financial cushion. We will talk about this later in the text.

What should you do to stay in the loop?

Many companies, until recently including my own, are guided by the principle that the amount of money they have is equal to the total amount on all the issued invoices- this is a mistake, and a serious one.

The amount of money you have is equal to the amount of cash currently in your account!

Alternatively, we may say that we have as much money as there’s cash in the account, and add to it the value of the fast-moving assets of the company.

So when, for example, at the end of the month you’re preparing a statement, in order to know how short you are in cash to cover your costs, you should rely mainly on funds that are physically in your account and nowhere else. Sure, but until the end of the month there are still 10 days left. I have 40,000 PLN in invoices, and 5,000 PLN in my account. So what? Should I take into account only this 5,000 PLN? To be brutally honest: YES!

If the sum of your receivables is diversified between many entities, there is lesser risk that something will go wrong.

Imagine, however, that the 40,000 PLN, which you should spend on paying taxes and employee salaries, is in the hands of one or two companies. On one hand, it’s awkward to ask for what is yours every now and again. On the other hand, when you’re pinned into a tight corner, there is nothing else but to “pressure” the contractors who still owe you money.

Financial cushion

The financial cushion is usually associated with personal finances, but it also applies to business. It’s a kind of a shock absorber that protects the company in case of unexpected events.

The bigger it is, i.e. the bigger the cash reserve in the account, the more comfortable running the company is Bartosz Majewski, in one of his blog entries, said that “a small software house is two unpaid invoices away from bankruptcy. The average one is one and a half invoice away”. This can be applied not only to software houses, but in general to the majority of small and medium-sized companies.

I work as a consultant with many entities. Some of them are companies that finance their operations with a loan, and the other part work with the money they get from their revenues or an investor. However, almost all of them make the same mistake: the mistake of not saving money. Those companies that are doing well or have raised money from investors are most exposed to consequences of overspending.

The first ones invest very aggressively. The latter see lots of funds in their accounts, which they treat as the mythical financial cushion, often not rushing to start making money on their own. How much should the financial cushion amount to?

It should be a multiple of monthly costs of running the business. The more months you can survive without “fresh” money, the more stable your cushion is.

Remember, however, that almost every cushion can be perforated, and the greatest havoc is caused by unpredictable expenses. It may turn out that instead of the planned 6 months, which we can survive without earning money, we will last only 4, because we had to make an unplanned investment along the way.

The mistakes we make while managing cash flow

Consumerism, or overspending. Spending cash on unnecessary gadgets, all kinds of crap which in no way builds the company’s value and is just the owner’s whim. This is not an investment!

Overinvestment. When we are doing well, we want the machine to go on and on, and on. Money is like coal in a steam engine. We must constantly add more to make the machine go further and faster. Unfortunately, oftentimes the rapid growth of the company causes shortness of breath, wrong investments or a faster increase in costs vs. the obtained income.

Lying to yourself while planning sales. How many times have you counted money from customers whom you haven’t signed yet, or how many times have you overestimated the chance of closing a deal just because the talks were promising? A cool head should be the basis of all your decisions, especially the ones regarding finance.

Counting the money you have not yet been paid. This is a very common mistake, because once we have issued the invoice to the customer it feels like we already have money. Another type of lie that we serve ourselves to feel better. Of course, if we know our contractors and we know that they are solvent, then sooner or later this money will reach us. It may turn out, however, that once we get it, we will have to immediately spend it on outstanding liabilities.

Forgetting to calculate the cost of debt. When we take a loan, we don’t check how much it will actually cost us and how it will encumber us on a monthly basis. It’s easy to spend someone’s money, but it is hard to pay it back with your own. I am not saying that loans are evil, because if we have a wisely calculated way in which we want to manage it, and how we intend to pay the liability off, it can work as our leverage.

Mixing private and corporate finance. Having no salaries and paying for company expenses with private cash and vice versa creates a huge mess. In extreme cases, we may not know how much money we really have in the company, and if we can invest it in something. Maybe the money which we want to spend should actually be reserved for things connected to our private life?

Expenses and priorities

You should keep a list of liabilities to pay, at the top of which will be the salaries of employees and key contractors who are the company’s growth engine. Subsequently taxes, social security and fixed fees without which it’s difficult to function in the company, i.e. a telephone plan, office, Internet, media, etc. Only once we take into account all these aspects, we can move to investment.

Expenses and investments

People are masters of rationalizing irrational decisions. That’s the way it is with all kinds of expenses. When we want to renew the office, we call it an investment. When we want to buy a nice car, but one that doesn’t work directly for us, we also call it an investment. This way, we allow ourselves to spend money we cannot really afford to spend. Only the things that really contribute to the growth of revenue in the company or the maintenance of this income can be called investments, i.e. purchase of a new machine, when the old one stopped working.

Forecasting

When you want to start looking into the future, unfortunately, you have to make forecasts, but not by reading the future in tea leaves. We all know that a sheet of paper or an Excel spreadsheet will take everything. Forecasting must first and foremost be honest, so no cheating. You can pretend that something is better than it actually is, but in fact you will just let your guard down this way and cause problems.

So how to forecast long-term, if you have never done it and you don’t know what will happen tomorrow? Use the method of three scenarios.

The first scenario is pessimistic. What will happen when the key customer leaves. What will happen when the machine responsible for 30% of production goes down, what will happen when you lose your key employee? This scenario allows us to plan finances and choose different variants in case a disastrous business year comes.

The second scenario is the most realistic, because we estimate it based on past years. We see, for example, that we have a 5% increase year-on-year, so we assume that we will grow by this much. In previous years, we had such and such problems, such and such challenges, so we simply think of financial management in case nothing spectacular happened. We do what we have been doing until now with the investment rate we’ve had so far.

The third scenario is optimistic and aggressive. It’s characterized by the fact that one must effectively separate optimism from fairy tales. Optimism doesn’t mean that we should set a 100,000% year-on-year growth target just because we like this number, and it’d be great if we managed to get such a result. We shouldn’t cheat ourselves, because it’s a waste of time. It’s a scenario that can actually happen, but is more optimistic than the “most realistic plan”. It means that, for example, we will be able to win 5 more clients, which will give us an increase of 25% instead of 5%, and additional funds for investments.

Scenarios for given forecasts can also be branched out, and thanks to the “road map” we can create many branches. Thanks to this, the knowledge about our company increases and we can predict possible problems much easier.

Creating these forecasts once a year would be nothing if we didn’t systematically control the direction in which we were going and didn’t apply corrections.

Let’s assume that we have adopted three scenarios, but the very first quarter shows that we won’t fit in any of them. The company grows twice as fast as the most optimistic scenario and we need to react, make changes so that it doesn’t turn out that a change that’s positive brings us a negative effect, e.g., mishandled coping with too fast growth.

Aggressive investment

In the years 2016-2018 I invested very aggressively in my company, which has resulted in more than 60,000 PLN in various liabilities (the amount was much higher, but thanks to overpaying from month to month, it’s getting smaller). Installments for equipment for recording materials (photo cameras, video cameras), loan, and private loans. What did it give me? I grew up very quickly, to tell you the truth. I experienced a some turbulence that could have killed me.

What have I learned from this? Above all, you should be cool about loans and installments, and analyze whether a given thing will be an investment or expense. Honestly, I have missed a lot of my decisions, which I regret. Aggressive investment should be made on the market that requires very fast growth or when we have a chance of very high acceleration, without exposing our company to turbulence.

In the last quarter of 2018, I made the decision that I want to build a company much slower, yet safer, without worrying about a real catastrophe when the key customer leaves, and the costs explode.

Liabilities repayment policy

Everyone has a different repayment policy. Due to the fact that I still have over 60,000 PLN to pay off, I decided to read a little more about getting rid of my debts. Of course, there are as many different schools and ideas as the articles themselves. Some write that you should only pay back what you need. If the monthly installment is 1,500 PLN, pay only that amount. Regardless of whether the current situation allows us to pay much faster.

Others say to overpay. I applied this second strategy. I call it “investing in your own debt”. Of course, this has nothing to do with investing, it’s more about getting rid of financial shackles faster, and thus the need to have an additional money transfer.

My bold plan for 2019 is to pay off all of my liabilities. This is an additional monthly cost of 6,000 PLN, which is not a small expense for a small company. Faster repayment will also allow me to start thinking about creating strategies for more than a year. This is especially important because our blog, marketingibiznes.pl, is growing a few hundred percent annually, and it’s likely that in 2020 it will need a large amount of funding to support growth. We always think better when we know that everything is financed from our own, not borrowed money.

Working it out with contractors

Due to the various financial obligations I mentioned above, I cannot always settle my liabilities on time (one of the goals for 2019 is to make payments to contractors regardless of the lateness of my payers). A very important skill is communicating about the problems and the potential date of their repair. When the contractor asks us if the money will arrive on time, we always answer honestly. This is not due to any dislike or even dishonesty, but only because of payment gridlocks. Hiding the head in the sand could cause the contractors to leave one by one, while in 2018 we parted ways with only one of them.

Finance management and health

Planning finances is always a lot simpler when we are healthy. Health also dictates our work rhythm which indirectly contributes to how much we earn. Whether we sleep well, or our vitality allows us to sit in the office 8+ hours, it has a huge impact on financial management. Well-being contributes to a large extent to whether we make bad decisions, including financial ones.

Do you want to manage your finances better? Here’s a checklist that will make it easier for you:

  1. Don’t spend any money that you don’t have in your account. Don’t plan to spend, invest, and distribute it.
  2. Create a system of gentle reminders about receivables. It may be the day before the due payment, two days after the expiry date, 5 days after the expiry date, etc. It is so-called soft debt collection, where you try to work things out with the contractor without having to transfer the case to the e-court or debt collection.23
  3. Approach differentiating between investment and expenses honestly. Cut as many expenses as possible.
  4. Optimize what’s possible to optimize in the company. Check if you have unnecessary subscriptions, the Facebook Ads campaign has too high budgets, or if all subcontractors with whom you are settling are necessary to develop your business.
  5. Create financial forecasts and write different scenarios for them. Assume that different things may happen.
  6. Every month or every quarter, analyze whether your forecasts differ from reality. There is nothing worse than a lack of correction for failed plans. Such action is a complete waste of time.
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