Sometimes it’s hard to see how good bookkeeping can save you money. After all, time is precious… and if you hire a bookkeeper, you’re spending money to save money (wait, what?).
Planning for Slow Periods
I was talking with a farmer client a few weeks ago; August is always a slow time and he has to watch his cash flow carefully. Not only are his sales low, but his wholesale restaurant clients are slow to pay him, because business for them is also slow. In fact, I overheard my client asking a worker to wait a few days to cash his paycheck. Given that he knows that August is always slow, he could plan for it.
During slow periods (like August or January), cash can be tight. If you don’t plan properly, a few things can happen:
- You end up charging items to your credit card or taking out short-term loans.
- You pay interest for loans. You could be taking on loans unnecessarily or even high-interest rate loans.
- If you fall behind on paying your vendors, you could be paying finance charges.
So how do you plan for slow periods? We recommend that you project cash flow for each month of the coming year to make sure you don’t run into trouble. Start by writing down your beginning cash balance (the total of what you have in your savings and checking accounts). Then, for each month, list out your projected revenues (cash inflows) and cash outlays for expenses, debt repayment or capital purchases. Then calculate the net cash flow for the end of each month by adding (or subtracting) that number from your previous month’s cash balance. If your net cash flow balance is ever negative, you need to figure out a way to increase cash inflow (by increasing revenue or borrowing money) or decreasing cash outflows (by decreasing expenses or delaying big purchases).
Drowning in Debt
If you don’t plan properly, you may have to take on unnecessary debt –– but even if you do take out a loan that is for business growth purposes, without the proper planning you can get caught in a downward debt spiral.
If all you see is cash flying out the door and debt mounting, you must first determine if this downward spiral is the result of poor operations or the burden of debt (that resulted from poor cash-flow planning).
With proper bookkeeping, you can see two things:
- Is your business able to operate profitably outside the burden of debt?
- Which loans are costing you the most?
You won’t be able to pay interest on a loan, let alone pay back the principal of your debt if your business is not generating a profit. To determine how much debt you can afford to take on (and thus pay back), you need to look at the terms of a loan and what the monthly payments will be. Plug these numbers into your cash flow plan and see if your cash flow balance stays positive each month. If you already have significant debt, look at your cash flow plan to determine how much debt you can afford to pay down each month.
As a general rule of thumb, always try to pay down the most expensive debt first (that is, the debt with the highest interest rate). If you have a loan at 6% and a loan at 12%, you want to get rid of the 12% as quickly as possible since in the long run you will end up paying out more money to service that 12% loan.
Understand What Makes You Money
A lot of businesses will combine all revenues into one big bucket. On the whole, your business may be profitable, but certain items in your sales mix or certain sales channels may be losing money.
For example, if you’re a restaurant serving brunch, how do you know it’s profitable? You can see on the whole that food costs are in line, or labor costs are in line, but do you know if serving brunch nets you positive income in and of itself, or might the high profitability from dinner cover the net loss from brunch?
The best way to understand what makes you money versus what doesn’t is to categorize your revenue and expenses by product/service or by sales channels. When you enter in your expenses into your bookkeeping software, categorize them by the type of revenue stream with which they are associated. For example, you might categorize the labor associated with working a farmers market separately from the labor associated with staffing a farmstand or harvesting. This way you will have the tools and information to dissect your revenue streams and see which make money and which don’t.
What happens if you don’t allocate your expenses properly? Often, business owners have a false sense of what is profitable and what is losing money:
- I was working with a restaurant that also had a CSA and wholesale business. They allocated 90% of the rent and utilities to the café even though other parts of the business used the space in equal proportion. As such, they viewed the café as a money-pit. They were ready to close down the café in favor of the other lines of business. In fact, the café brought in extra cash and promoted their CSA.
- Another restaurant group I worked with allocated all their administrative expenses (payroll services, bookkeeping, HR, etc.) to just one of their units. As such, it looked like that unit was operating unprofitably and were about to close it. When the distributed the admin expenses across all three unit (based on the portion of revenue) was the most profitable of all of them.
Questions to Ask Yourself:
- Are there certain times during the year when you are always tight on cash?
- Do you know how much interest you’re paying on debt every year?
- If you didn’t have debt, would your business be profitable?
- How much debt can you afford to take on and be sure you will be able to pay it back?
- Do you know which of your products/services is the most profitable?
- Do you know if any your products/services is not profitable?
If you can answer “yes” to all these questions, congratulations! If not, it’s time to get your bookkeeping system in order. A great place to start is by using QuickBooks and creating a cash flow budget. Need more help? Give us a call or email.