The old saying, “revenue is vanity and profit is sanity but cash is King” is true. Unfortunately, it is all too common that business owners are blindsided by the revenue of their business.
In the past 20 years I have had the opportunity to speak with many business owners about the financial side of their businesses. I am always amazed at the lack of knowledge about the importance of a good cash flow in business.
Even worse are those business owners who don’t have a good grasp of their financial situation and get caught up in a “revenue race” where impressive revenue numbers take precedence over actual profits. If your business is eating up all of your revenue, it would be better to start at zero.
If you have been struggling with your cash flow, you may want to take a look at how you can better understand the financial situation of your company and avoid getting into a revenue race.
There are bad revenues
A successful business is not just about revenue. You could say that a business is impossible without revenue. There is bad revenue.
I’ve seen small businesses chase millions of dollars in corporate or government contracts, and leave themselves with less than 10% to secure revenue. These ‘big’ deals are doomed if they have long payment terms or are late.
It’s important that more businesses learn this: it’s okay to reject revenue if it isn’t profitable. Revenue does not always equal profit. This is especially true if the revenue you are seeking can only be obtained at a high cost.
The 10% rule
The 10 percent rule can help you ensure that your cash flow is healthy and allow you to easily invest in your business.
Ensure you’re operating at the right gross profit level for your category. Each small business should operate with a net profit of at least 10%. If you have a business worth $2 million, your net profit should be $200,000.
Remember that 10% of the profits will be reinvested in your business after COGS, COS and all other expenses are paid. It is important to do this first.
Say you’ve just completed a $100k deal, received $100k in payment, and know that you still have to pay suppliers, lenders, and employees. First, you pay your business. $10k goes directly into its profits account. Set up a separate business account. Every single invoice or deal that is paid should follow this rule. Even if the invoice is $100, you must add $10 to your profit account.
Paying yourself first and then the business profit account, lenders and suppliers should be paid next.
This habit of ‘10%’ will help you to turn your profits into cash, which can be used to pay off a loan, to invest in capital, or to expand.
You will be surprised at how fast your profit account will grow if you try it for a whole month. You may have to adjust your prices if you’re having trouble meeting a deadline for a loan, or you need to extend the timeline.
The key to a successful cash flow is not to get too excited about your revenue if you don’t have the profits to support it. If you cannot save 10% of your profits, then it is time to change.