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Financial expertise

This One Tactic Will Increase The Value Of Your Business

By October 2022October 31st, 2022No Comments

Ask a business owner if more profit results in more cash, and they will almost certainly say Yes! But cash is a lot more slippery than profit, and to maintain a cash-rich business you need to really target it and work to increase your cash reserves. These are my tips for targeting cash.

Business owners and managers know they need to keep a careful eye on their profit and loss account (P&L) and will often have targets for sales and profitability. It’s only when money is tight that they turn their attention to their cash flow. I think this is a mistake and I advise all our clients to target cash as well, especially during times of uncertainty.

Right now, a lot of businesses seem to be overvalued and economic sentiment in banks and with VCs is down. Interest rates are also low, so it’s not a good time for investment. That’s why smart companies are avoiding debt and shoring up cash. Down the road, when opportunities come by or a competitor is for sale at a good price, these are the companies that will be able to act swiftly.

How to get more cash into a business

At its simplest, you target cash by bringing more of it into the business faster, and by delaying (or stopping) it from leaving the business.

I always think of cash flow as something which is ‘resultant’, meaning that it results from whatever has occurred in the profit and loss sheet. But you can’t just expect it to materialise, it’s not unusual to see a client has €200,000 in profit but only €100,000 in the bank.

Being aware of this allows you to influence what happens to cash. Focusing on a few key numbers can make all the difference if you want to increase your cash reserves. In particular, collections and stock have a big effect on the health of your cash reserves (more on these below).

Some reasons for cash to not materialise are:

  • buying personal items through the business
  • lending money
  • paying loans off too quickly
  • paying creditors sooner than you have to
  • not chasing late payers
  • investing too much in fixed assets
  • letting too much stock accumulate

There are probably 50 ways to lose your cash. But that also means there are tangible decisions you can make to plug the leaks and nurture your cash!

Targetting cash starts with your budget

It seems obvious to say, but the whole point of sales is making cash. While we all understand the idea that we set budgets for profitability, I see very few businesses that set budgets for cash. This is where I suggest you start.

Let’s say you’ve set a sales target, which you meet. The result of that should be increased cash. If you’ve set your forecasts at the beginning of the year, they should tell you how much that cash increase should be. It’s then a simple task of comparing the forecast against the improvement in your bank account and learning from it. Did more cash come or not?

No matter the business, we advise all our clients to update their budgets in Q4 so that everything is in place from the first day of the new year. It’s crazy to start a new financial year without knowing what you’re aiming for in terms of sales and profit. But once you’ve nailed this down, you can also include targets for cash. This means you go into each new month with a clear picture of what your sales, profit, and cash growth should be for the period. (If you haven’t done your 2023 budget, get in touch for business planning support.)

Budget reports in software like Xero don’t natively show you cash variance, which I think is a big gap. They will show variance for your sales budget and profit budget, but I’ve never seen one that shows cash budgeted versus cash generated. So, if you’re a Xero user, you need to use the Cash Summary report to see where your cash came from and went to, although you won’t see the variance from your budget.

If you have a CFO service from us, we can do this for you as part of our management accounting reporting. One of the benefits of having a CFO working with you is that they will help you adopt the right habits when it comes to cash. I see that investors (and banks) are pushing the importance of cash reports more than they used to, and that can only be a good thing. I think it’s a result of best practice from big multinationals trickling down and becoming habits within SMEs.

Set and monitor your budgets right, and you will finish next year with a big chunk of cash. Ultimately, this is where the value of a business comes from.

Two good cash habits to adopt in your business

Target cash through collections

If your credit window is too generous, your cash flow will be directly impacted. The result will be that receipts don’t come through quickly enough to keep your business running smoothly. Ideally, you will find ways to reduce or avoid giving credit at all, which can be done by invoicing upfront, issuing interim invoices, introducing a monthly charging model, only delivering the goods or service once payment has been confirmed, and direct debit collections. Automation tools such as GoCardless and Chaser are handy for improving your credit days and your cash flow.

Target cash through stock

If you hold a lot of stock, you are tying up your cash. Stock management is fundamental for improving cash flow and making sure you keep unnecessary costs down – ensure you’re not holding stock for too long, maintain positive credit terms with suppliers, avoid wasting stock, and improve stock turnover. Efficiencies in stock management will directly improve cash flow.

Cash isn’t a four-letter word!

Hopefully, you will see now how adjusting your thinking about cash allows you to make decisions that will lead to more cash in the business. However, don’t get too granular about your cash flow. Targeting cash involves making broad assumptions rather than narrowing down on individual transactions. If you are completely focused on short-term cash and are exposed when a single invoice payment fails to appear, your business is being run without sufficient cash reserves. Ideally, a business will have between 3 and 6 months of costs covered by cash reserves; if this is not the case, it may be that the business is simply undercapitalised and requires investment.

It is possible for your sales and profits to be doing well but for cash reserves to be low, which is why I suggest having a budget. In addition, you could incentivise your team to increase cash reserves on a quarterly basis. This way in your budget you will have a target cash reserve that is compared against what you actually have in the bank. The result is that cash is now front and centre in the conversation, as it should be, giving you the ability to enter the next year on a stronger footing than the last.

Cash affects the value of your business

The amount of surplus or extra cash your business generates is directly related to the value of your business. If you are not generating additional cash, your business does not have any value apart from keeping you busy and potentially giving you a salary. We encourage you to aim higher than this.

We help clients with financial health checks, business planning, and budgeting. If you’d like to move to Beyond Accounting, get in contact today or call 01 639 2963.