As small businesses grapple with rising costs of fuel, goods, and labor, maintaining profitability can be an ongoing challenge. Inflation reached its highest level in 40 years, with the rate of inflation Consumer Price Index (CPI) at 8.5% in July. Moreover, food prices increased by 13.1% compared to last year, which prompted consumers to cut back on their spending on many non-essential items. For small business owners, the task of setting competitive rates while covering costs and maintaining cash flow can be challenging.
The value of a business is related to its ability to maintain a healthy cash flow and generate sales. Cash flow is a snapshot of normal business operations. If there is more business flowing than is coming in, there is a problem. In fact, lack of liquidity is the main reason why most small businesses fail.
Business owners can take the following steps to maintain a healthy cash flow and further protect the value of their business.
Analyze key financial data and identify opportunities for improvement
Your financial statements should be reviewed on a regular basis to monitor your business performance. Sales may seem steady, but do customers pay their bills on time? You may have enough cash on hand to cover costs, but is it improving performance? A successful business must grow in revenue over time.
Perform a cash flow analysis. Start by preparing your cash flow statement, which shows you how much money will flow into your business and how much will flow over a certain time frame.
- Review cash flow for operating activities, including money from accounts receivable, money paid to suppliers, payroll, and non-investment taxes, as well as depreciation of business assets.
- Reviewing cash flow for financial activities, including funds used to make business loan payments, issue stock to shareholders, or other financial obligations.
- Reviewing cash flow for investing activities, including financial spending to purchase or sell assets not related to normal business operations, such as business equipment, machinery, and real estate.
Tips to increase cash flow:
- Improve accounts receivable. Follow up on unpaid invoices. Create payment plans with late paying customers. Create incentives for customers to pay on time and penalties late.
- Check the terms of accounts payable to see if you have a grace period to delay payments. Consider reviewing your terms.
- Reduce expenses. Find ways to eliminate any unnecessary spending. Re-negotiate prices with sellers or shop for less expensive alternatives.
- Reassess inventory needs. Buy less if you’re in stock or look for better bulk prices if needed.
- Reassess prices. Look for areas with room to increase profit margins or raise prices on high-demand, specialized services that only you can provide. Also use competitive research to see how your rates stack up against others in your industry.
- Reduce supply chain risk through supplier diversification. Alternative sellers can also increase your options for better rates and availability.
- Consider a small business line of credit to maintain cash flow.
Perform a profit and loss analysis. The profit and loss statement (or income statement) shows the revenues, costs and expenses incurred during a certain time frame. Is your business profitable as it should? Are you missing opportunities to generate additional sales?
- Review sales over time. Identify any peaks or patterns that you may be able to repeat. A previous marketing campaign may have succeeded in increasing revenue per customer.
- Review the sources of income. Identify sources that are profitable and worth scaling, as well as sources with lower margins that are worth less time and resources.
- See seasonal patterns. Identifying the seasons when demand is high or low can help price strategy, production, inventory or even employment.
- Review the cost of goods sold. Usually, your revenue should go up as the cost of merchandise goes up. If not, there may be a red flag.
- Review net income and profit margin. The net income ratio (profit margin) can be used as a baseline across different time periods, as well as a comparison with your industry. To calculate the profit margin, divide net income by net revenue and multiply by 100.
Estimating the value of your business and creating an exit plan
Protecting the value of your business begins with knowing the value of your business. Business valuation is not only important for long-term planning or selling your business, but also for determining growth strategies, obtaining financing, attracting investors, and more.
With inflation still a problem for small business owners, many of whom are still recovering from the pandemic, requests for business evaluation are on the rise. This is especially true for those agonizing over retirement and facing a dilemma…