As I am sure you are aware, there are two sides cash flow; the money coming in and the money going out. Though there are a myriad of cost reduction strategies, it is interesting to know there are only three ways to boost incoming cash; increase sales, borrow money, and investments from the owners. Let’s look at the pros and cons of each.
1. Increase Sales
Pros – Unrestricted use of the money
Cons – You only keep pennies out of each dollar earned based on your net profit. Marketing and sales strategies must be effective. Outside factors such as competition, economy, regulation, technology and innovation all affect sales.
When you make a sale, it’s simple. You put the money in the bank. The biggest factor affecting this cash flow is when sales are on account. That is, when you invoice your customers to pay you later. In this case, you must maintain an accurate listing of your outstanding receivables and manage the collections of the money due to you. Other than that, once you have the money, you have unrestricted use of the funds.
How could there be a downside to sales? You are certainly aware of the costs involved with running a business. Depending on your bottom-line net profit, you only keep pennies on each dollar. For example, if you are only netting 10% after all the bills are paid, you are only keeping 10 cents of every dollar of sales. When put this way, it sounds dismal. However, this is what a business is; the ability to generate a profit on the expenses invested in the business. Once you are making more than you are spending, you are generating a positive cash flow over time.
There are other challenges with making a sale. Your marketing strategies must be effective in bringing you potential customers. Your sales process must make sure those customers buy something rather than walk away. Competitors will do all they can to draw your customers away. Sometimes there is a downturn in the economy that erodes the demand for your products. Technology and innovation can render your offerings obsolete.
In each case, you as a business owner must have a strategy to offset the threats to your sales. What is your Plan B for marketing, pricing, recession, and technological innovations? Think ahead about the possible risks to your business and have an implementation plan ready when they occur. And if you have been in business for a few years, you know these risks are real.
2. Borrow Money
Pros – Immediate use of the lump sum of money, over time it may improve your credit score
Cons – You must pay it back, plus interest, it causes a future cash flow burden, it adversely affects financial ratios, it has a short term impact on your credit score
Should you be in the position to borrow money, you must have a plan in place to pay it back. This borrowed money should be treated as an investment such that it generates far more revenue than it costs you for the interest you must pay.
There are many lending sources available to a business. But it boils down to one thing. Risk. The risk the lender has on your business will dictate the interest rate you will pay. And debt comes in many forms. Financing vehicles and equipment is in essence, borrowing money because you didn’t have to deplete cash to buy these assets outright. Some companies use accounts receivable financing, selling outstanding invoices to a third party in exchange for a lesser amount of cash. The company benefits from the cash it gets today and transfers the burden of collections over to the third-party lender. Even the use of credit cards is a form of lending, especially if you are not paying the outstanding balance in full each month.
Borrowing money also has an impact on the company’s financial ratios. Lenders look at the level of debt in relation to the income the company generates as a gauge of the company’s financial health. Short-term debt can adversely affect the credit rating. Though a history of servicing debt, paying it back, can boost ratings.
The point being, there are many creative ways to secure funds for your business. All these strategies come with a financing burden… the lender isn’t giving you the money for free. The savvy business owner knows financing can be quite beneficial when the returns far outweigh the future cash flow burden and when the cost of the funds, the interest, is a reasonable amount to pay.
3. Investment From Owners
Pros – Immediate use of the lump sum of money, interest free, no repayment obligation
Cons – Need new investors or current owners are investing from their personal funds
The investment from the company owners can be seen on the company’s balance sheet, labeled a variety of ways depending on the company structure; investment by owner or partners, common stock, preferred stock, paid in capital, members capital, or additional paid in capital (APIC). These funds represent cash or assets the owners have contributed to the company in exchange for a percentage equity ownership in the company’s success.
Because it is not a loan there is no obligation to pay it back, and interest does not accumulate. Instead, this represents a percentage ownership in the company with the benefit of sharing in distributed profits (dividends), or when the company is sold.
When times are rough, it may be difficult to secure funds through financing, or the rate of interest does not justify the loan. And if the company is unable to increase sales, investment from owners is the only remaining option. For most small businesses, this means investing your own money into the company, or asking friends, relatives, and colleagues to invest. When others contribute, they will want something in return. Either in the dividend distribution of earnings, or an equity stake in the company when it is sold. Another way equity ownership is expanded is when key employees, vital to the company’s success, become shareholders through bonuses and stock ownership plans.
The downside to bringing in outside investors is the dilution in ownership percentage of the existing owners. More will share the profits, if any. But what if there is a loss? Usually, the investors do not participate in the downturn of a company. If the company eventually goes out of business, then they lose their investment, or only get pennies on the dollar for the sale of the company’s assets.
In summary, the most favorable way to generate more cash is to increase sales. That is why there so many books, coaches, and online resources on the topic. Yet there are times when financing makes sense, if the benefits outweigh the costs. And there are also times when equity ownership makes sense. When there is a need for more cash in your business, evaluate these pros and cons of each source. And get the advice and opinion of a trusted source.
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