“An ounce of prevention is worth a pound of cure.”
– Benjamin Franklin
As optimism grows among consumers that the worst of the pandemic is behind us, many are venturing out again (sans mask), shopping, traveling and socializing with friends and family. Yet the financial symptoms of the pandemic still linger with rising inflation, high energy and gas costs, shipping backlogs, higher cost of labor, product shortages, and rising interest rates.
“In a poll carried out on behalf of CNBC last month, 81 percent of US adults said they believe a recession is likely in 2022. By contrast, Goldman Sachs economists recently put the odds of a US recession in the next year at 20-35 percent.”
– CNBC
Predictions are never easy to make and surely not assured, but still with the current state of the world, it’s always a good idea to take stock of your small business’ risks, assets and financial health. We learned in March 2020 how easily our world can change overnight, and that we must be prepared for the highs and lows of economic changes.
So let’s consider five ways to prepare for any bumps in the road ahead, reduce stress, keep your business profitable, and face any future risk with confidence.
I. Ensure you have Cash on Hand
What is Cash on Hand? It is finances set aside for unexpected use, whether a rainy-day fund, personal and professional emergencies, unanticipated investment, expansion opportunities or an economic downtown (or recession). Having cash on hand will keep your business afloat and prepared for the tough times, as well as provide security and flexibility to take advantage of opportunities that may come your way.
Cash on Hand is defined as physical cash, money in bank accounts or assets that would take less than 90 days to liquidate into cash. To increase cash on hands, identify ways to reduce or eliminate costs, even for the short-term, to bulk up your COH reserves. Set aside a consistent and reasonable percentage of your profits each month to be deposited in a separate account to build your Cash on Hand account, as if you were paying a loan payment or other debt. Consider taking less money out of your company when it is profitable for personal use, even when it might be tempting to do so.
How much Cash on Hand that you set aside depends on your stage of your business (whether startup or well-established), your business goals, your industry, and seasonal fluctuations that affect your business and your specific business model. We recommend the following:
- New Startups in their first year of business: $10,000 cash on hand.
- For Established Businesses that have been in business for up to five years: Three months of fixed expenses (payroll, rent, utilities, monthly loan payments)
- For Well-Established Businesses that have been profitable for 5 or more years: Six months of fixed expenses (payroll, rent, utilities, monthly loan payments)
Need help? Call Innovative Accounting for a personalized plan on determining how much cash you should have on hand or to talk about Cash Flow Forecasting.
II. Diversify your Income Streams
Some businesses do very well solely relying on one or two very large clients; or focus their client base in a niche market or industry. For example, one client focused on providing marketing and multimedia creation for realtors and brokers, but when the real estate market weakened a few years ago, their business was greatly affected and they had to reset, reboot and refocus their product to appeal to different industries, while in the midst of crisis mode. A small business owner never wants to greatly alter his product lines or modify income streams while also juggling a financial crisis, which is why nearly 200,000 businesses failed during the first year of the pandemic.
Rather than being completely reliant on a single income stream (one industry type, one to three clients or one product that only appeals to a niche market), create a safety net in case one or more of your income streams dry up. Not only can diversifying your income prevent issues during the downtimes, but it can also increase profits, create new opportunities, broaden your business’ brand even during a booming economy.
There are many strategies out there to create multiple streams of income including getting creative with new ideas, expand to the digital space, looking for untapped resources in your industry, or expanding services to your existing client base. The point is … don’t be afraid to try new things. Think outside the box, and don’t let yourself be limited by fear. Its much easier to implement change when things are calm and profits are predictable. Protect your finances, stay organized and consult with your financial professional before you begin.
III. Lower Debt to Income Ratio for Your Small Business
Your debt-to-income (DTI) is a ratio that compares your monthly debt payments to your monthly income and accounts receivables. To calculate your debt-to-income ratio, add up all the payments you make toward your debt during an average month. Next, divide your monthly debt payments by your monthly income to calculate your current DTI. If the number is indicative of a problem during the good times, that could be a clear sign you may not survive the bad times.
If you’re not sure if your current DTI is healthy or how it can be improved, consult your accountant or financial professional to get a more accurate analysis, as well as ways to decrease debt personalized to your particular situation.
If you foresee an economic downturn ahead for your industry, now is the time to decrease the burden of monthly debt and overhead. Here are some ways to decrease your small business debt:
- First, increase the amount you pay each month towards your debt, so you can more aggressively lower your overall debt.
- Second, consider seriously before taking on more debt, unless absolutely necessary to the continued success of your business. Before you incur further debt, analyze and research the financial risk to ensure that the debt will provide secure profit growth, diversified income streams, or future growth of your business.
- Third, refinance, renegotiate or consolidate existing small business loans to reduce monthly payments and pay off loans as soon as possible.
- Fourth, postpone large investments, business expansions, acquisitions, hiring additional staff until DTI is improved.
IV. Manage Accounts Receivables with a Focus on Collecting Outstanding Payments
The quickest way to improve cash on hand, lower debt and prepare for future downturns to collect existing cash owed to you. By having an organized approach to payment collections, you not only keep your lights on but can actually improve customer experience. If you are feeling the process for collecting late payments can be tricky and awkward, you are not alone.
“A study found that the average small business in the United States is waiting on $84,000 in unpaid invoices — with 81% of those invoices being over a month past due.”
– Entrepreneur.com
While its important to build strong relationships with your clients, those relationships won’t help your business if you are not getting paid. So here are a few ideas on getting paid without having to walk on eggs while you do it:
- Communicate clearly your payment schedule, including payment forms accepted, and consequences of late payment BEFORE you begin working with a new client. Have it in writing and have your client sign the contract with payment terms included so there are no surprises later.
- Have a regular schedule of sending detailed invoices with a clearly seen payment due date on the invoice and late fee penalties terms on the front of the invoice.
- Send polite follow-up emails prior to the due date, on the due date and regular intervals post-due date. If no response, follow up with a phone call or a video meeting.
- If the customer is unable to pay and has fully communicated the legitimate reasons that prevent full payment, set up a personalized invoice schedule to ease their burden and increase chances of actually getting paid. Make suggestions of a repayment schedule with reasonable late fees, that feel collaborative.
- Contact other people at the company if you are not getting a clear response from your point of contact.
- Consider moving to a recurring, or automated payment schedule, or requesting payment up front for work if your business model permits. This greatly improves cash flow, virtually eliminates bad debt, and saves you and your staff time and money following up on overdue invoices and collections.
V. Consider Financial Analysis and Forecasting
What would happen if a future recession resulted in a loss of 20% of your current profits? What would happen to your business in the short-term or long-term in various worst-case scenarios? Do you currently have a one-year, three-year or five-year plan business plan?
We offer the following financial analysis services to show what you are currently doing and how you need to change in order to reach your goals:
QuickBooks Annual Budget: Get control of where your business is going with an annual budget created and managed in Quickbooks. This is what really drives businesses forward, knowing where they want to be and working towards their goals.
In-Depth Forecasting, Projecting, & Budgeting: We use forecasting softwares, to create and maintain multiple budgets, forecasts, and scenarios to give you the information you need to confidently make business decisions. This is for the business that has grown to have many moving parts and needs a cohesive way to bring them all the data together and see how making a change would affect the business in the long run.
Cash Flow Forecasting: Forecasting for the profit of your business is not the same as forecasting how much Cash you will have available. Debt Payments, Owner’s Distributions, Accounts Receivable are all items that may result in a company having no Cash on Hand to pay their bills even if they are profitable. Managing your cash flow is integral to having a successful business.
Financial Analysis: Are Profit & Losses and Balance Sheets all Greek to you? We use advanced analysis tools to provide you with an easy to read report with insights and metrics that actually let you know what you are doing right and what you are doing wrong. We measure and monitor KPIs (key performance indicators) that matter most to your business. We use charts, tables, and visually appealing graphics to make your financials simple.
In Conclusion …
“Success depends on previous preparation, and without such preparation there is sure to be failure.”
– Confucius.
No one can perfectly predict the weather even for the week ahead, so whether or not a recession in truly in the forecast, it’s always a good idea to prepare your business for the rainy days that are sure to come. Also, the five points above also make good business sense and when implemented can take your business to greater heights even during a booming economy.
If you need help with your financials or are interested in any of the services above, contact us for a no strings, no pressure initial consultation.
