How to keep track of cash flow and use it to build your business

How do you know what cash you’ve got coming into your business? Can you afford to buy more stock or move to new premises? The numbers in your business hold the key to making good financial decisions which won’t give you sleepless nights.

We asked Daljit Virdee, of DSV Accounting who has 18 years experience in accountancy & tax for businesses, and now works as a virtual financial director, what business owners need to know to use their numbers.

This is a transcript of a conversation in the Drive The Network Facebook Group.

Ann Hawkins Let’s start by looking at the kind of information you consider to be essential for businesses of whatever size to be aware of Daljit. Is it turnover, profit, or something else?

Daljit Virdee Essential: Certainly Turnover and profit. Also, I would look at: gross profit, profit before tax, and profit after tax. I would also ensure you have a firm grasp of what your fixed cost base is – that is the costs which your business would bear even if you made no sales. The key bit after that is to look at your gross profit and net profit *margins* (i.e. as a % of turnover).

Other essentials would be on your balance sheet: A critical area is your liquidity. There are a few ways to look at it, but essentially, it is looking at the ratio of your current assets to your current liabilities. For most here on Drive, as small service-based businesses, that would be, for example: (Cash in the BUSINESS bank account + client fees outstanding) – (Overdraft actually used + suppliers due to be paid). The ratio should generally be more than 1:1.

There are many more, but it also depends on the industry and type of business.

What do you need to know about your business finances?

Ann Hawkins I’m sure that has already sent a lot of people scurrying for the duvet! Can you take those one a time and say why they’re important Daljit?

Daljit Virdee Gross profit: Your turnover, minus the costs specifically incurred in order to generate that turnover (called Costs Of Sales). So using DressCode as an example: The Costs Of Sales would be things like the material used, the labour and cost of machine time, heat and light directly needed for manufacturing.

Profit before tax: As it says on the tin – what’s left over after all your costs, but before tax.

Profit after tax – as above, but minus tax.

Emma James Gross profit is one that’s often surprisingly overlooked, in my experience. It’s all well and good working hard to build a business with say a £100k turnover, but if it costs you £90k to produce those products/services then you’ve only got a £10k business and that £15k a year office you’ve just signed up to is no longer looking like such a good idea.

How to keep on top of your finances

Berenice Smith Do you have top 5 tips or essentials that every business owner needs to know?

Helen Lindop As micro businesses, what’s the best way to stay on top of our financial info?

Daljit Virdee These are the most important:

1. Keep on top of your bookkeeping!! Nowadays, this is best automated as much as possible, using one of the many cloud based apps available such as FreeAgent, Clearbooks, WaveApps. An important part of good bookkeeping is to be timely, code things correctly (you could ask Emma or me if you get stuck, or your bookkeeper/accountant, if not us), and code things consistently.

2. Management Accounts!! You’re really missing a trick if you’re only keeping on top of your bookkeeping to do your year end accounts and taxes. Get more from the figures by using them to evaluate your performance, where you can be doing better, how much cash you might have to spend back on the business. I’ll go into more detail on this later…

3. Forecast! Look at your past performance, estimate how sales and costs will continue in the next 12 months, and review your performance against this forecast monthly. This goes for both cash and profit, because the two things are very different. Again, I’ll expand on this later…

4. Check creditworthiness of prospects. How many of us actually check that new customers are both able and willing to pay our fees?

5. Have a separate business bank account! One of the best things to do – especially as a Sole Trader (it’s actually a requirement for a Ltd Company) to keep on top of your cash flow and it helps massively when using accounting software to automate more, as well as keeping on top of your drawings from the biz.

Ann Hawkins OK. We’ve got the “what”. Can we look at the “why” now? Why is this information important? What difference does it make to decisions? What would happen if people ignored it?

Daljit Virdee The most pertinent and important one would be to make the most of the cash your business has, and the assets and relationships it can leverage.

Normally we start by looking at how much cash is ‘tied-up’ in the business. This is usually cash sitting with your customers in fees outstanding, and may also be cash already paid to your suppliers for things which you have yet to make sales on. The idea is to get cash in from customers sooner (if not in advance) and pay suppliers later (but still within agreed terms to maintain a good relationship, which may lead to better terms or more credit in future).

Freeing cash up like this could give you the extra cash you need to help your business grow – for example you could then have a PA / VA, or even a Part Time FD.

However, to do any of this, you need to do at least points 1 to 3 above.

You need to leverage your cash

Daljit Virdee Business is all about leveraging, and the thing most in your control to leverage is your cash. So, the other part to expand on is cash forecasting…

This is to look at the *timing* of when cash will be coming in, and when it will be going out, and the expected bank balance at the end of each month.

By doing this, you can identify any ‘pinch points’ during your year, and therefore look at when you might need to make additional sales or reduce costs, or defer bills, to smooth out your cash flow.

If you’re likely to be growing, it can also help identify when you are likely to have a cash surplus to allow you to either draw more cash for yourself, or buy things you need for the business.

Look at the  “lifetime value” of clients.

Looking at the value of your clients in this way can actually give you a budget for marketing.

Simply put, assess how much in gross profit (see above) you’re likely to make from the customers you’re trying to attract (will need research to arrive at a reasonable figure) over the whole time they are with you, or even over a projected 5 years. That figure is then the maximum amount you have to spend to land each client. Obviously if they all cost that exact figure, you’re not making any profit, so, really, you want to be below that by a % which: (1) contributes to your fixed costs (again, see above), and (2) leaves you a bit extra (this is essentially what you earn from them).

That’s for acquiring customers, but do you look at how much you make per *existing* customer after all related costs, and what your effective hourly rate is?

Create a system so you can see which services are most profitable

One of the things great about management accounts is that there is no prescribed format. They can be what you want them to be, because they are for you to assess your performance by the measures you deem relevant / important. It’s brilliant! No one needs to be afraid of doing this. Like anything, just have a go, and it can only get better.

This means that people often divide management accounts into what we call “verticals”. Just think of it as a Profit and Loss statement (basically a listing of sales, costs of sales, and all other expenses) split into columns, where each column is a separate income stream. So, for example, if you have a multi-faceted business where you do website design, training courses, and admin work, you could see how well each of the businesses is doing. It can really put things in context, and help you see where you would like to, or should, focus your energy. It may even show you if one of the areas is making a loss!

You can then decide on whether you want to develop a struggling area, or drop it and develop stronger business streams (“verticals”). You might even decide that you don’t care if a particular area is loss-making because you love doing it, and the other profitable parts allow you to carry on!

Being able to do this relies wholly on the quality of and detail within your bookkeeping.

So, in the same way described above, you can actually apply this to looking at which customers are making you more money. It all depends on being able to separate and track the sales (that’s the easy bit) and costs *related to each customer* (the hard bit if the bookkeeping hasn’t got enough detail). You can then look at the profit for each customer and divide by the hours spent dealing with each, and decide on who you may want to develop / drop / reduce costs, etc.

Would you like to know more? Contact Daljit Virdee or follow him on Twitter @dsv_accounting.