The Issue

You’ve been in business for a few years, maybe longer, and have been rightfully focused on building it up and growing sales. You know you have been successful because there is always money available at the end of the day. But growing sales is only one side of the profit coin – the other is management and control of costs and expenses. Managing and reducing costs to optimize profit margins gives you a competitive edge, and especially when times are tough, better leverage.

Businesses that take steps to ensure their operations are as lean and efficient as possible in tough times are not only more likely to survive, they will emerge that much stronger when conditions improve. But to understand where there may be fat to cut, you must first understand your cash flow and your financial business model – what your business looks like in terms of revenues and costs.

What to do?

For starters, get your accountant to provide you with a Profit & Loss (P&L) statement and identify and explain what flows into each line/cost item. Challenge everything and anything. Does each item make sense to you and align with your understanding of your business? Do you understand what are fixed costs, variable costs, direct costs and indirect costs? What ability do you have to influence them – in the short term, in the long term?

• Look at ratios, percentages and margins. Review labour costs as a percentage of sales; cost of goods sold as a percentage of sales and gross margins. Regard ALL line items as a percentage of sales. After all, it is your sales that pay the bills for everything else in your business.
• Perform a trend analysis on historic data with side-by-side comparisons of spreadsheets that show P&L, with the ratios and percentages, for each year. Look for any changes in ratios over time, find out the reasons for these changes and determine if the changes make sense in light of your business development. Address any that don’t!
• Benchmark ratios and margins against other successful businesses in your industry. Draw on your accountant’s experience, your peer network, and data from chambers of commerce, market research firms, or professional associations (such as retail and manufacturing associations, depending on the business and industry your are in). See if you are under-performing relative to these benchmarks. If so, do you know why, and what can you do about it. If you are doing better, can you leverage this advantage?
• Prioritize your costs/expenditures. Divide everything into two lists – Must Haves versus Like to Haves that are not necessary. Get rid of any items that are not necessary to the operation of your business and ensure you have the right controls in place to keep them out. A lot of hidden costs can creep up in this category – such as interest on outstanding credit card payments, banking fees, travel and entertainment. Many of these items may be slumbering under “Miscellaneous,” so monitor this line item to keep it in check. You can look at optimizing some processes around these (such as banking fees) and balancing them against cash flow requirements. Employee expense claims in particular can be an area where poor oversight can quickly lead to weaker margins.
• Set targets and make budgets using a planning tool with monthly, quarterly, or annual P&L statements. Identify whatever strategies you need to meet the targets and implement them. This includes optimizing processes such as approving and paying invoices. Are invoices circulating for days before they can be approved and paid? Are you making the most out of early payment discounts? Consider a purchasing order process. Many accounting software packages already include modules for this, otherwise it can be done with Excel. There are two benefits:

i) Purchases are approved upfront, prior to the invoices arriving, making invoice processing much faster.

ii) It gives you that much more transparency on upcoming expenses and payments, and therefore more flexibility to be pro-active in managing your costs (and cash-flow).

• Consider using credit cards as a method of payment wherever possible and collecting points that can be used to cover travel costs. But always be sure to pay off credit card bills when due. Cover any cash-flow deficits with a line of credit, not via expensive credit card interest rates.
• Move payroll as much as possible to a monthly cycle and electronic payments. 
• Challenge suppliers for better terms and switch fixed costs to variable ones. Take a good look at any flat rate fees you pay, especially for services, and the volume and frequency of use of these services. Are you using all that you are paying for, or would you be better off arranging a more discretionary use and payment? Track your performance and analyze variances to ensure you understand them and they are justified.
• Lastly, involve your employees. The expense claims cited above is only one example of the myriad ways that employees can impact your cash flow and the costs that eat into profitability. Ensure they have a clear understanding of the influence they have, both positive and negative, on the overall financial health of the organization.

If your business is in need of a short-term cash boost, the organizations that you can turn to will be far more receptive if you can point to clear and decisive measures you have taken to cut spending, increase sales and improve cash flow to more efficiently operate your business. It’s always easier to get help if you have demonstrated that you have first tried to help yourself.

Measures to improve cash flow include:

• Educating yourself. If you’re not familiar with bank statements or accounting statements, work with your advisor to be sure you understand cash flow, what it means to you and understand the issues. I’ve seen people who think their business is broke, and yet, they have a $150,000 in receivables on the books. One business owner was paying his creditors in two days, but giving his customers 30 days.
• Collect on your receivables. Don’t let customers use their debt to you as a form of credit. Consider offering them a quick payment discount as an incentive to pay early.
• Delay paying payables. By the same token, don’t put a creditor’s nose out of joint by using them as a form of credit. But don’t pay the bill any sooner than you are obligated to do so, unless there is some kind of obvious advantage, such as the incentive of a quick payment discount.
• Be co-operative and communicative. Everyone’s facing the same challenges. Be open and transparent with customers and suppliers and work together to establish a schedule for payables and receivables that everyone can live with.
• Manage your inventory. If you are in cash-and-carry business, such as retail, allow your inventory to drain a bit. Retailers typically carry at least 20 per cent more inventory than they should at the best of times. Cutting back on inventory can provide a big boost to cash flow. If times are tough, suppliers are more than likely dealing with their own inventory bloat and have the stock on hand to quickly resupply your business if the need arises.
• The loonie factor. On the other hand, if you import product, pay close attention to currency changes – be quick to take advantage of what is effectively a discount on foreign goods when the value of the Canadian dollar rises and stock up.

Sources of financing to consider

If, after putting your cash flow under scrutiny you still see the need for external financing, here are some options to consider:

Business Development Bank of Canada
BDC is a federally mandated institution dedicated to providing small- and medium-sized businesses with the financing options and consulting services they need to succeed. It offers venture capital to start-up and early-stage companies, subordinate financing for companies that are in transition, expanding or planning an acquisition, and term loans for businesses at various stages of development.

BDC does not offer grants, interest-free loans, lines of credit, or other services typical of a full-service chartered bank, such as bank accounts, term deposits or GICs.

To learn more, visit www.bdc.ca.

Ottawa Community Loan Fund
The OCLF provides short-term loans of up to $15,000 to small business owners, aspiring entrepreneurs, talented individuals with international training and community groups. It is a private organization that works with other community-based financial organizations to qualify borrowers, who must be able to demonstrate a worthwhile business concept, practical work experience and/or training, and a solid business plan.

To learn more, visit www.oclf.org.

Small business loans
Full-service chartered banks offer a diverse range of business services, including small business loans. These fixed- and variable-rate term loans are typically secured and reserved only for the purchase of long-term assets that support your business growth, to refinance an existing debt, or to fund a business expansion or acquisition. If your need is to cover a short-term gap in your cash flow, you need to discuss with your banker other options, such as a credit line.

To explore your options for a small business loan, arrange to sit down and have chat with your banker. RBC, for example, offers these options and terms for a small business loan.

Export Development Canada
EDC is a federal agency that provides financing, insurance and bonding solutions to Canadian companies that export goods and services, or that invest in other countries. On the financing side, it provides a number of services to support international transactions, such as paying for the up-front costs associated with the production of a large export order, to expand into new markets or to respond to a buyer’s request for financing.

Learn more about the various financing options EDC provides for exporters.

Friends and family
Never overlook the resources that are closest to home. Friends and family can come through for you in a pinch when institutional lenders will not. The challenge is to make sure to formalize any arrangement on paper to prevent family feuds or bitter estrangements. For example, in return for a cash investment, a family member can be given a convertible share. And pay interest on any loans with a formal repayment schedule.

Customer financing
This isn’t always a viable option, but you never know until you ask. Depending on the circumstances, a customer may be willing to make an upfront payment or a series of milestone payments. This is much more likely if you are recognized as a stable and trustworthy organization and you have a longstanding relationship with the customer.

With one of my ventures, we had a customer in the telecommunications industry who wanted to spend $350,000 on a product we hadn’t even developed yet. To secure this product, the customer was willing to pay 95 per cent of the value of the order up front to finance development. The customer was also in a bind where it needed to spend its budget before the end of its fiscal year, which played to our advantage.

And lastly, a note on personal exposure

It’s worth mentioning measures such as drawing on retirement savings to help float the business or using one’s home as collateral to guarantee a bank loan. But this kind of personal exposure can be risky and should only be considered as an option of last resort. Look before you leap and make certain you fully understand all the implications.

If you do put personal money into your business, ensure you cover it with repayment plans and loan agreements to get it out tax free. I have often seen people put money into their business, then declare it as income and pay income tax when they pay themselves back. This IS NOT taxable income. This is the repayment of a loan you have extended to that separate entity known as Your Business, Inc.

The issue

Business people know that their business cannot effectively operate without proper cash flow. The issue is to gain an understanding of the details of your businesses cash flow needs, anticipate problems and have solutions. In general if your cash flow has deteriorated and the bank is calling you to repay a demand loan or you cannot make payroll for your employees, you have reached a point in your business with limited options. If you plan properly, you can hopefully avoid this problem.

First: Gain understanding of your business cash flows

Gain an understanding of what cash inflows are generated by, and what cash outflows are required by,  your business on a monthly basis. Review prior monthly financial information (financial statements, bank statements) for historical data and trends and really understand your business’s ability to generate cash and consume cash.

• If you are a retailer, when do you pay for your inventory and how soon does that inventory result in cash inflow to the business?
• If you are a business which sells on payment terms, know what the average collection period is for a sale. Sales are not cash flow if you cannot collect the cash.
• How much do you purchase from suppliers, when do you make the purchases and what are the payment terms to your suppliers?
• Does your business have periodic payments such as insurance which could be paid over 12 months instead of a single payment?
• Know when your GST and income tax liabilities are due. Do not ignore the required remittances and instalments as the government will not let you borrow from them and there are consequences for personal liability, as well as interest and penalties costs, if your business stops making required payments.
• If your business has a cycle of slow sales periods each year, review how much cash you need to have to get to the next busy sales period. This means knowing what the cash consumption of your business is each month for rent/ mortgage payment, salaries, communication costs, vehicle payments and operating costs, and similar costs.
• Integrate your vacation into the cash flow. If you’re absent on vacation, the business may not be selling (if you are a consultant) or you are paying for someone to replace you while you are away.
• Integrate your personal cash needs from the business. Understand when you will need to take cash from the business for personal needs. Be realistic. If you cannot take cash from your business to live, the personal stress may affect your ability to operate the business.

Second: Use your understanding of your business cash flows to create a planning tool

Use the above information to create a detailed cash flow statement for a six- to 12-month period. The Entrepreneurship Centre can assist you in details of how to prepare this document. The cash flow statement is meant to give you information so you can anticipate cash flow challenges in your business. 

Why take time to create this cash flow statement?

• You need to understand your business before you can ask others to help. If you need an increased line of credit, it is better to anticipate that need than to ask for an increase at the last minute to allow the business to meet a payroll obligation. Lack of information indicates that the business is controlling you.
• It is difficult to make purchase decisions and hire staff if you cannot anticipate business cash flows.

You have to make estimates of future cash inflows from sales. While actual results will vary, you now have a cash flow statement tool to allow you to plan, adjust and react.

Third: Cash flow problems will happen – how to react

Virtually all businesses will have cash flow problems at some time in the life of the business. Slow sales consume cash and so can rapid growth. There is no ready solution for all problems, but review your alternatives. Communication with your employees, suppliers and the bank will be critical to get them on board and trust that you have identified the problem and are working on a realistic solution:

• Determine if the problem is a temporary (large cash outflow for unexpected repairs) or longer term (loss of a major customer, new competition driving down prices). If temporary, consider approaching suppliers or your landlord to defer payment for a month. If you have a mortgage, ask the bank to rearrange principal payments for a certain period. Consider temporary layoffs or job sharing to reduce labour costs. Review your business assets and sell redundant assets to create cash flow. Consider selling inventory at reduced prices to create cash flow.
• If longer term problems exist, review your ability to borrow against your home equity or refinancing existing debt. Consider selling required assets and leasing them back from the purchaser to create cash flow. If the business is at a growth stage where you cannot finance the growth and the bank will not provide further borrowings, consider a business partner who would inject cash into the business.