In the kitchen and bath industry, as with many industries, there's always a tendency to get caught up in the urgent needs of our businesses and just assume that we'll deal with the future when it gets here. But, for most of us, when change does occur regardless of whether it's positive or negative we require some time to react and adjust our businesses accordingly.
In order to provide us with the time required to make the
adjustments to changing circumstances, it's important to have some
sort of "rainy day fund." In theory, good forecasting, cash flow
projections and overhead management would provide plenty of warning
of impending cash crunches, but the reality is that most small
businesses are not very sophisticated at this. This month, we'll
look at some of the ways to manage our cash positions and the
options available to us to help us be ready when that crunch
What You Need
The first step in evaluating what you'll need to be prepared for the unexpected is some thumbnail cash projections. This can be done fairly easily by analyzing the activity in your bank account for several months and developing some averages. In doing this, group the payments that flow out according to how much flexibility you have in timing them. Some costs are not very flexible, such as payroll, taxes and rent; payments to sub-contractors might offer a little more flexibility, and vendor payments can be quite flexible by negotiating extended terms with some suppliers.
Now that you have some data on your cash requirements, you can do some "What if?" scenarios to see what might happen if your revenue stream were to be disrupted. There are many ways that revenue can be impacted: Sales drop off and the stream of down payments is less than anticipated, a large customer fails to make a promised progress payment, a project is halted by weather, permit problems, etc.
There are also situations where you get hit with unexpected costs: Storms, theft or accidents can disrupt your business and may require, at least temporary, large cash outlays. Since most of our businesses have only a handful of projects underway at any one time, any of these situations could produce a significant hit to our cash flow.
When one of these events occurs, it's important to recognize the situation immediately and react as quickly as possible to deal with the impact it will have on your cash flow. Evaluate the situation to enable you to make a judgment as to how serious the impact will be and whether it will create a temporary or long-term change in your revenue flow.
If the situation is temporary and will correct itself, such as delayed progress payments, then you probably only need enough cash, or flexibility in your cash flow requirements, to bridge the delay. If, on the other hand, it appears that the disruption to your revenue is more long term in nature, such as a drop off in sales, you will need to take action in order to bring revenue and expenses into balance.
So, how much of a cushion should you have to see your business through these times?
There's no hard and fast answer, but here are some guidelines.
As a minimum, your business should always have available enough
cash reserved to cover one payroll. And, as an ideal, you would
give your business much greater freedom if there were one month's
worth of cash flow available in your rainy day fund.
Most kitchen and bath firm owners face many more demands on cash flow than can ever be met. New tools, computers, raises, etc. all cry out for your limited flow of revenue. In analyzing the activity in your bank account, you'll see that many expenditures fall into a category that might be termed "discretionary." Many of these can be delayed, deferred or forgone entirely.
What this means is that you could add to this list a payment to savings as an additional discretionary item. Setting money aside for rainy day savings account is not much different than trying to save on a personal level. The key to success is to set a goal and establish a regular, systematic method of adding to the savings.
Again, as with personal savings, you should start with achievable goals and savings levels to work toward. The best way is to attach the savings deposit to an event that makes it automatic. There are a couple of different approaches to this. One is to save a fixed amount periodically and the other is to tie the saved amount to cash flow.
In the first approach, you would set your initial target goal at one payroll, say $12,000, and then pick a benchmark to make your deposit. One possibility might be to deposit $500 each payday into your rainy day account. In 24 paydays, you would reach your initial goal. Once you have established this pattern of setting aside an amount on a regular basis, you'll find that it will be easier to continue it.
The other approach functions much like a sales tax, in that you would establish a "tax" rate of say 1%-2% of your collections and deposit this amount to your savings each time you make a deposit to your regular checking account. If your initial goal is the $12,000 mentioned above, the 1% savings rate will allow you to reach it on collections of $1,200.000.
To ease the pain of this rainy day saving, you could also add 1% to your sales margin when you're estimating projects, or to your overhead charge if you work on time and materials. In either case, it's unlikely that a 1%, or even 2%, increase in your pricing will cause you to lose a project.
Once you have established this savings account, you'll find that it will give you a degree of freedom that you have not enjoyed in the past. When it comes time to purchase that new truck, piece of equipment or other major capital outlay, the money will be there. Even more important, when you need to walk away from a potentially troublesome project, you won't feel compelled to take it simply to keep cash flow going.