James and Megan dive deeper into February’s theme of Finances. In the last show, they gave you an overview of the fundamentals to business financial literacy. This episode is about the ins and outs of managing your business finances.
Today’s Kryptonite: Revenue and Expenses!
Why aren’t finances just money in minus money out?:
- As we said in the last show, Cashflow is King! If it was just money in minus money out you could have $100 of revenue and $80 of expenses leaving you with $20 of profit. However, if you have $80 of expenses due the first of February and you don’t get paid the $100 of revenue until the first of March, you’re operating on a negative cash flow of $20. You cannot sustain a business with a negative cash flow.
- Even if you have a positive cash flow, you need to have sufficient profit. Remember, you’re running a business and you need to be profitable so you can stay in business. Your profit needs to be healthy enough to cover downtime or slow periods in your business.
- Finally, you can’t just deduct or write-off any expenses you want. As a business, you’re subject to IRS scrutiny. There are rules regarding allowable expenses and what the IRS deems reasonable and necessary.
What strategies can help us win financially?:
- Ask yourself if you’re charging enough. Keep in mind, when you’re running a business, you’re not only trying to cover your materials and time to delivery or create. That only covers your cost of goods sold. You need profit beyond that to cover your Selling, General, and Administrative (SG&A) expenses. These include your cost of sales – the time you spend on business development, marketing, networking, and so on. Your overhead – things like your website, hosting, office expenses, insurances, utilities, etc. Don’t forget taxes and some extra for retained earnings.
- There is a misnomer out there, especially among service providers. The thought goes like this: I can work 50 weeks a year, 5 days a week at 8 hours a day. That’s 2000 hours, I can charge $50 an hour and earn $100K per year. While the math works, this is employee thinking – not business thinking. It ties you to trading dollars for hours. Also consider: is it ethical for your clients to pay you by the hour?
- You can’t book yourself this solid and still have time to run the business and have a life. You have to price yourself to cover the cost of sales and your downtime.
- One area to look at on the revenue side is the payment terms you have established with your clients.
- Are you operating on Cash on Sale or Delivery?
- Do you have terms such as Net 15 or Net 30?
- Do you have payments set-up?
- As an enticement, you may want to offer a discount for full payment up front.
- Just because it’s a write-off does not mean you need to take that expense. Is it a reasonable and necessary expense? If it’s questionable, you can raise red flags with the IRS.
- Just like with revenue, you need to look at the payment terms you have established with your vendors. You want them as long as possible.
How can I implement these strategies?:
- If you operate on hourly billing, change that with new clients to project or value-based pricing. Then with your existing clients, switch them over to your new pricing strategy for the next project or billing period. If they demand hourly pricing, make sure you have enough margin to be profitable.
- If you’re not getting paid upon sale, negotiate the shortest payment terms possible and offer a discount for payment in full upfront.
- Now what about those expenses? Scrutinize your expenses – are they necessary? If you’re paying for a service, are you using it? If not, cancel it!
- Negotiate with your vendors if possible. Try to get the longest payment terms possible or get a discount for paying early. Remember, Cash Flow is King!
- Take what expenses you can that are reasonable and necessary. Document, document, document. These could be vehicles, mileage, home office, utilities, your cell phone, internet access, etc.
- Look at your Accounts Receivable (A/R) and Accounts Payable (A/P) terms and understand if you have a positive or negative cash flow. If it’s negative, negotiate what you can to get a positive cash flow.
- Analyze your pricing strategies, benchmark if necessary, to ensure you are profitable and that you are covering your cost of sale.
- Review your expenses with your CPA.