Increasing cash flow in a small business with a case study and worked examples
Increasing cash flow to a small business is like increasing oxygen flow to an animal.
Imagine if you will, your small business cash flow like a flowing waterfall after a good fall of rain. Imagine in the above image that the water tumbling over the edge of the waterfall is cash flowing into your bank account.
Good cash flow is fundamental to the survival of any business, big and small. Whereas increasing cash flow is vital for business growth and development.
Cash flow is the life-blood of the business. However, if you are able to discover ways of increasing your cash flow, better still.
In this article I’m going to discuss the ways of increasing cash flow, with examples and a case study.
The result of increasing cash flow is you’re more likely to have a healthy bank balance. You will be less stressed as a business owner. Plus you’ll have more freedom to grow and develop the business from the excess cash in the bank.
Increasing cash flow from operating activities
Increasing cash flow from operating activities can be achieved in a number of ways.
Operating activities represent the main trading activity of the business. Operating activities are the activities that directly affect an organisation’s cash inflows and outflows, and determine its net income or profits.
The business’s cash inflows are the result of the receipts from sales. Sales are different for each business, but can be the sale of either goods/products or services or both.
The business cash outflows result from purchases of stock or inventory (cost of sales), payments to the suppliers of the business overheads together with other business expenses. These would include wages and salary costs, rent, rates, utilities, marketing and advertising, postage and stationery and so on.
Ways of increasing cash flow from operating activities
So there are a number of ways of increasing cash flow from operating activities. This can be achieved by either increasing cash inflows, by reducing cash outflows, or a combination of the two.
So lets begin with increasing cash inflows and improving cash flow from customers.
Ways to increase business sales and improving cash flow from customers
In order to increase business sales and improve the cash flows of the business, the business must do one of the following:
- Make more sales to existing customers of existing products or services.
- Increase the number of customers and sell to these new customers.
- Introduce new products and/or services.
So let’s take each one of these was of improving cash flow in a small business in turn.
Make more sales to existing customers of existing products or services.
There are a few ways to increase sales to existing customers.
The first is to improve the business’s average transaction value. The average transaction value is calculated by dividing the total of all sales transactions over a given period, by the number of transactions over the same period.
How does this work? It works because if you have a given number of transactions from a given number of customers, and you increase the amount that is spent on each transaction by those customers, sales would increase by default.
Average transaction value example and case study
This is better explained by way of an example. Let’s say a small business has 1,000 customers. In this case study each customer buys 6 times per year. In the first example, customers spend on average £55.50 each time they visit (i.e. the current average transaction value).
Sales for this business would be calculated, as follow: 1,000 x 6 x £55.50 = £333,000.
However, if we increased the average transaction value to £60, the revised sales for this small business would increase to £360,000.
This is calculated as 1,000 x 6 x £60 = £360,000.
The improvement of £4.5 in the average transaction value, resulted in increased of sales of £27,000. This represents an 8.1% sales improvement.
Increase the number of times customers return using the same case study example
In the above example customers returned 6 times per year. So in total 6,000 products are sold each year.
If we assume the business could get existing customers to return 7 times per year instead, this would increase annual product sales to 7,000.
The resulting sales from this increase in the number of times customers return would achieve revised sales of £388,500.
This is based upon the existing average transaction value of £55.50. For example: 1,000 x 7 x £55.50 = £388,500.
That’s an increase in sales of £55,500 over the 12 month period.
What if we combine the two improvements in this case study?
If the two improvements are combined, that is the average transaction value is improved to £60 and the number of times customers return is increased to 7, sales would jump to £420,000!
That’s a whopping £87,000 increase., which represents a 26.1% increase to sales.
There are other ways to improve sales to existing customers too, but I’ll leave these for an other article.
However, it’s when you begin to combine the effects of these changes that the real magic happens.
Imagine in your business where you could increase sales by £87,000. This would represent extra cash flow in your small business.
Increase the number of customers and sell to these new customers
The second option, is to increase the number of customers we have. In other words we are growing the business’s reach.
Increasing the number of customers can be achieved essentially in two ways.
Improved sales and marketing
The first way is to increase or improve advertising and marketing. To achieve this you can either spend more on marketing and advertising. Or alternatively, improve the efficiency of the current marketing activity.
Or of course a combination of the two.
Improve your conversion metrics
The other way to increase your number of customers is to improve your conversion metrics.
The conversion metrics I am referring to include the conversion of visitors to leads, conversion of leads to prospects, conversion of prospects to customers.
If you improve on each one of these conversion metrics in your sales process, you will increase your rate of customer growth exponentially.
Imagine combining the improvements to conversion rates with improvements to your average transaction value and with the number of times customers return.
Not only will your sales increase, but your cash flows from operations will automatically increase too. This is the power of leverage.
Introduce new products and/or services
Through introducing new products or services, and by actively promoting these to both existing and new customers, your sales will increase.
One of the best ways to discover new products or services is to ask existing customers for their feedback.
The most productive way to achieve this is through a customer advisory board.
By asking your customers for ideas on new products or services, you are giving them what they have asked for. This becomes a no-brainer and will lead to increase in sales in increases in cash flows too.
It’s not just about increasing sales, but also about improving cash flow using credit management
Increasing sales will not automatically improve cash flows, unless you have a good credit management system in place.
All businesses must have a robust customer credit control system to collect amounts due from customers on a timely basis..
Invoices should be raised either immediately at the point of sale or soon thereafter.
Once invoices are raised, it’s important to have a system in place to ensure the receivables are received. where customers are given a credit period to pay, keep on top of the credit period.
Make sure you allocate credit limits. Plus ensure you have a robust system to make sure customers are kept within their credit limits and terms.
Increasing cash flows comes from the increased sales that are collected on time and through keeping bad debts to a minimum.
Reducing cash out flows
The other side of the coin to increasing cash flow from operations is to reduce or delay your cash outflows.
Increasing cash flow in a business is the net effect of the both sides of this equation.
What are the ways to reduce cash outflows?
Firstly, cash outflows can be improved through the delay of payments to suppliers. This can be achieved through careful negotiation with your suppliers. Improvements to your payments terms and the delay of when you pay for your supplies will improve your cash flow.
The added benefit to delaying payment to your suppliers is that it’s free credit. So never under estimate the power of this free source of credit to your small business.
Reducing cash outflows by cutting or reducing costs
The other way to reduce your cash outflows is to reduce your cost of purchases together with your overhead costs and expenses.
This can be achieved either by re-negotiating terms and rates with your existing suppliers. Or you could find alternative suppliers at a better rate.
However, never cut costs at the expense of quality or service. This may work in the short term, but in the long term this will not be good for business.
Cut costs out all together
You could review your overhead costs and see what costs and expenses are not required.
I always recommend to review monthly management accounts and the year end profit and loss to see how money could be saved.
Keeping an eye on what is spent by the business will keep overheads in control. This will have the effect of reducing your cash outflows, which will result in increased cash flows.
Set budgets to restrict what is spent.
Having a budget will force you and your employees to focus on what they buy. This will keep a level of control over what is spent, rather than spending for the sake of it.
Prepare cash flow forecasts for at least the following 12 months. This will serve a number of purposes. The first is you will have a budget to work with and keep control of expenditure.
Secondly, your’ll have a sales target to work towards. Thirdly, by preparing cash flow forecasts you will know what to expect over the next 12 months.
Having cash flow projections is a good planning tool. It helps to avoid any nasty surprises.
What are the advantages of increasing cash flow from operations?
The advantages of increasing cash flow from operations was explained at the beginning of this article.
The main benefit is your business will have more cash in the bank. It will also be able to take advantage of opportunities to grow and invest for the future.
The other advantage of having better and improved cash flow is peace of mind. Running a business is stressful enough as it is, with out major cash flow problems to contend with.
Better cash flow equates to lower stress levels. Lower stress levels results in a healthier body. Lower stress allows you to think more clearly and to focus on growing the business.
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