PART 2: Solving The Cashflow Puzzle, What Causes Cash Shortfalls & What To Do About It
In Part 1 we looked at the scary, but meaningless, statistics around cashflow and business failure and answered the question how much cash is enough cash. In Part 2 we are going to take a more detailed look at the specific actions that result in cashflow shortfalls with businesses and what actions you can take to avoid becoming part of this atrocious statistic.
What are the causes of cashflow shortfalls in businesses?
In my 20 plus years of being an accountant I've had plenty of time to contemplate this question beyond simply business expenses exceeding business costs. Here's the ugly truth, according to my world-view:
Insufficient funds to start
It takes time to get a business established and it also takes money to invest in infrastructure, people and marketing, all the while food still needs to be put on the table. It can take a good three to five years (or longer) before business income alone is sufficient to meet the cost of living and pre-business life-style.
Poor tax and super management
There are three reasons for this:
Some new business owners are ignorant of the taxes and super that they need to pay and don’t invest in understanding their obligations.
Employees get paid what’s left after the taxman gets his share and super. Business owners get paid gross and have to divvy it up between the taxman, their suppliers, employees and themselves. New business owners aren’t used to being paid this way and spend what should otherwise go to the taxman and super.
When starting up every dollar counts, and when there aren’t enough dollars to go around tax and super are missed. This is the reason why it is so essential that a business has sufficient capital from the start.
There is lots to do when starting and growing a business, so it’s head down doing the work and generating sales. Managing the compliance aspects of the business is not a task that most people enjoy and therefore avoid. When the business owner finally comes up for air, they have an enormous tax and super bills that they don’t have the money to pay.
Business owner not paying themselves properly
This is an issue for business owners operating as a company, which is often the preferred structure for businesses. The reasons for this being:
When there is surplus cash accumulating in a business bank account it is all too easy for the business owner to simply spend it or transfer it to a personal account. This creates a loan between the company and the business owner, a situation the taxman doesn’t like. If the loan isn’t repaid or a complying loan entered into before the earlier of the lodgement of the tax return or the due date of the tax return then the taxman will deem an unfranked dividend. This results in a rather unpleasant tax result, which can manifest in the following ways:
a) The company pays tax at 25% on company profits and the business owner doesn’t get the benefit of any franking credits (credit for company tax paid). The business owner is taxed on the unfranked dividend, according to the marginal tax rate schedule.
b) If the company had paid the business owner a bonus, director’s fee, salary or wage the payments would have been tax deductible to the business. A dividend is paid from profit and is therefore not tax deductible. To ensure your payments tick all of the boxes to being tax deductible you might like our blog 5 ways to pay yourself from your company.
There can be a desire to keep tax as low as possible and to do this the business owner pays a salary where their marginal rate of tax is less than the company rate of tax, leaving excess profit in the company to be taxed at 25% . This becomes unsustainable in the long term as the business owner eventually wants to do something outside of the company with the money, which means paying tax and in some instances it can be a lot! You can read more about this in our blog The problem with leaving profits in your company.
Business owner’s lifestyle costs exceed the capability of the business to fund it
I am going to admit that what follows may involve judgment on my part, something that I try desperately not to do. However I am human and a product of my own upbringing, values, beliefs and world-view. I have seen good businesses earning good money (enough, in my world-view and the world-view of others), but not enough for that of their business owners who choose to buy luxury boats, luxury cars, extravagant holidays, upgrade homes, designer shoes and designer clothes at the expense of meeting their financial obligations as a business owner.
This may fit with the values of the business owner, however for those that value the sustainability of their business, maintaining and improving their lifestyle over time and long term wealth creation, to me anyway, it clearly isn’t the path to take.
Lack of a plan
I am not a fan of elaborately documented plans, but every business owner needs to have a plan even if it is just in your head. I confess that I have never documented my business plan from top to bottom, but at the same time I definitely have a plan. Plans can be formulated with your own thoughts, discussions with business consultants/coaches or discussions with other business owners that result in actions on a to do list (or they can be detailed and documented, if that is your thing). The important thing is that you have carefully formulated thoughts that result in actions to bring your dreams to life. The plan will include how to generate sales, manage costs, grow a team, funding and more.
Poor financial management
A business owner who doesn’t have up to date knowledge of their business financials has no visibility over income, expense or tax management. With cloud accounting solutions, such as Xero, there is no reason for business owners not to have up to date financial information on which to make business decisions. I have worked in accounting firms that specialised in insolvency work. The vast majority of the businesses that I saw going through the insolvency process had very poor financial (ie no) financial records.
How do I manage cashflow?
This is our final question, and for me as an accountant, the easy one to answer. There are a few things in your business that you can do to make sure that you don’t become part of the atrocious statistics for cashflow difficulties. These are:
Understand you, and your cashflow requirements.
Have a plan for how you are going to fund the first five years of your business.
Have a plan, fullstop.
Keep your financials up to date and ask your accountant how to review and read your profit and loss and balance sheet.
Put a budget in place. Our case study, How knowing your numbers can save the day, has an excellent example of using a budget together with up to date financial information to highlight an issue within a business.
Consider a cashflow management system. We like Profit First. Our blog 4 Cashflow-management principles guaranteed to be a gamechanger outlines this simple process and our blog Case Study: Cashflow Management demonstrates the value of the system.
Consider the risks to your cashflow. A good risk management plan will include insurance (business & personal), estate planning, business structure and business processes.
Managing cashflow can be overwhelming and I understand why, as there are so many components to it, questions you need to ask and questions you need to answer. However, if you take away nothing else from this blog, remember that at the core of managing cashflow is understanding your values and your relationship with money.
If you would like specific advice tailored to your business and circumstances, Accounting Heart offers affordable service packages where you can work with Sonia one-on-one to help you get your business where you want it to be. Book your FREE Discovery Call to find out more.
Disclaimer: This is general information only and is not advice of any sort. No warranty or representation is provided by Accounting Heart Pty Ltd as to the accuracy, currency or completeness of the information contained in this blog. Readers of this blog should not act or refrain from acting in reliance upon any information contained herein and must always obtain appropriate taxation and / or other advice as may be appropriate having regard to their particular circumstances.