Revenue is EGO
Profit in SANITY
Cash is KING
In this article, I’m going to talk about some of the five cash traps in a contracting business and explain to you how to manage these effectively and improve cash flow. The benefits of mastering this skill include having a clear financial picture, making informed decisions, and ensuring the longevity of your business.
The 5 cash traps in a trade contracting business:
- Inventory: a build-up of materials with low turn rates
- WIP: not invoicing as quickly as possible
- Low Margin or Losses: doing more work at low margin sucks cash
- Debtors: Slow payers
- Defects / Rework: going back to fix errors burns profit/cash
Unfortunately, many business owners and managers overlook the importance of cash flow. They often focus solely on profit, neglecting the vital indicators that cash flow provides.
The Primary Reason: Lack of Financial Knowledge and Processes in the business
Many don’t invest the time to understand the basic financial data essential for their business. Here are some reasons why trade business owners struggle with cash flow management:
Reason #1: Not fully using accounting software like Xero, Quickbooks, or MYOB. Old data is a common problem.
Reason #2: Neglecting monthly or quarterly financial obligations such as BAS, IAS, and Superannuation returns.
Reason #3: Not reviewing Profit and Loss and Balance Sheet regularly enough. (once a month does not cut it)
Reason #4: Failing to monitor Debtors and Creditors’ reports – chasing debtors is a necessary pain in the backside. But like Nike says’s ‘Just Do it”
Reason #5: Not having a clear cash flow forecast.
But there’s hope! I’ll guide you on how to overcome these challenges and manage your cash flow effectively.
Step 1: Implement Efficient Accounting Systems It’s crucial to have web-based accounting software in place. Ensure your chart of accounts is set up correctly and that all bank feeds are activated for easier bank reconciliations. This step is foundational. For instance, software like Xero and Simpro can automate many processes, making cash flow management more straightforward.
Step 2: Regularly Review Financial Reports Always review your Profit and Loss and Balance Sheet as regularly as possible. Doing a monthly financial review is essential, but you must also have a weekly (sometimes daily) view of your profitability. Understand your gross profit, the difference between mark-up and margin, and the cost of sales. By doing so, you can identify which jobs are profitable and which aren’t, allowing you to make informed decisions.
Step 3: Monitor Debtors and Creditors. Keep an eye on what you owe and what is owed to you. Implement automatic follow-ups for overdue invoices. This ensures that cash flows into the business, reducing the risk of cash shortages. Have someone in the business who wakes up every morning excited about how they will get your lovely clients to pay today. If it’s not their only job, at least have them report on the cash position each week.
Step 4: Understand Your Numbers. Dive deep into understanding material and labor costs and how they affect your gross margins. Educate your project managers on these numbers and hold them accountable. Job management systems like Simpro will help show the P&L on each job and the projected Cost To Complete – as long as the system data is accurate.
Profit is a matter of opinion: Cash is a matter of fact.
For smaller trade businesses (under $1mil), I recommend reading “Profit First for Contractors” by Mike Michalowicz. In his methodology, Michalowicz emphasizes the importance of taking profit first and then managing expenses with the remaining cash. This approach ensures that your business remains profitable and sustainable in the long run.
Conclusion
Managing cash flow in a trade business is about more than just monitoring the cash in the bank. It’s about understanding the numbers, making informed decisions, and implementing efficient systems. Whether you’re a seasoned owner or a young entrepreneur, mastering cash flow management is crucial for your business’s success. Remember, the numbers are your dashboard; with them, it’s easier to navigate the business landscape.