Sales boom. Business fails. Why?
"Sales are growing every month!" my friend Tom told me proudly three months ago. Today he's about to close his business.
"What went wrong?" I asked.
Tom was stressed, going through a horrible time, "This is a nightmare, I can't pay my bills. I have two months that I haven't been able even to pay myself."
"But, what's wrong Tom? A few weeks ago you told me that you were growing in sales every single month. Now you can't pay your bills? How are you spending your money? You have pretty good margins, it doesn't make sense."
"Hector, the more I sell, the more I'm deeper getting in trouble. I'm always anxiously waiting for payments to arrive, I have my credit cards maxed out and spending three to four hours a day on the phone calling my customers requesting money."
"What?" I interrupted him, "You're spending hours on the phone calling customers because they haven't paid?"
"Yes, I started this 'net 30' sales strategy that I read in a book. It has worked wonders with our sales results, but it has drained my cash resources. I'm waiting for things to get better but I don't see this happening anytime soon," said Tom.
Tom's "net 30" strategy demand customers a full payment within 30 days. If Tom had a "net30" $1000 invoice, it meant that his client must pay in full on or before the 30th calendar days of when his goods were delivered.
Tom focused on sales and ignored cash flow. This is common error entrepreneurs encounter in business that quickly becomes a nightmare.
What can we learn from Tom's mistake?
Tom's sales strategy was delaying cashflow.
- He performed the job.
- He sent the invoice.
- He got paid (hopefully) 30 days later.
While Tom waited for payments, he had to pay for everything; materials, labor and the company's fixed expenses. While Tom had similar "net30" or "net45" agreements with his vendors, he never expected this would happen.
Startups die without cashflow.
As entrepreneurs we're commonly focused on startup expenses and business growth that we ignore the working capital that the business demands.
Here are some things that Tom realized (these are not a rule of thumb):
- Tom started to demand a significant down payment. This down payment covered all expenses associated with that given sale. By doing so, he could cover all fixed costs and delayed his profit when the final payment arrived.
- Another strategy Tom implemented was requiring faster payments. Invoice clients net15 days, instead of the net30.
- Today Tom is also implementing a "2% 10 net30" deal to his clients. The notation "2% 10, net 30" indicates that a 2% discount can be taken by the buyer only if payment is received in full within ten days of the date of the invoice and the total amount is expected within 30 days. Today's payment tools make it easy for customers to pay invoices right from their mobile phones.
- After negotiating with his vendors, Tom eventually learned to balance his cash flow by asking his vendors to delay invoicing to 45, 60, or even 90 days to allow ample time for payments to clear.
Tom had established a good relationship with his vendors. They were all willing to work with him once he explained his strategy to get back up.
Among the challenges of entrepreneurship, cash flow management is at the top of the list!
When you start your business, imagine going underwater!
- Your ability to survive underwater (keep the business running) depends ONLY on your tank filled with breathing gas. (Cash)
- If your tank runs empty, you will need an emergency source to extend your life underwater. (Some financing.)
- The moment your “breathing” quits, your business dies!