How to manage money in any business.
Money in a business is like oxygen to humans; we don’t live to breathe, but we have to breathe to live. The business does not exist only to make money but without money the business wouldn’t even exist. The problem with entrepreneurs and business owners is that they have this grand idea for a business, but they often lack basic knowledge of how money works and how to manage money in their business!
Unfortunately, many business owners rely only on one report called the P&L, which is the profit and loss statement, which can be misguiding. The best way to understand money in the business is to refer to a water tank. Read this text to know how to manage money.
How to manage money – money flow and water tank
Let’s imagine a tank which has outflow and inflow. If we pay our suppliers, pay for rent or wages, we have ‘water’ flowing out. If we get paid – then we have ‘water’ flowing in. If there’s more water that flows out, then obviously the level of the water will go down. And if there’s more water flowing in, then obviously the water level will go up. So how to manage money in business is truly as simple as that, but business owners should be aware of profits and loss statements. The reason behind that is because the P&L shows the first line as sales – and sales are based on the invoices raised. If you raise an invoice, it will show straight away as a sales item. But if you want to stay on top of your finances, you should only count the money that has physically entered your bank account or any other way into your business.
How to manage money – count only the money that entered your account
If you raise an invoice without getting paid for it first, then the only thing you’re doing is you prepare an empty cup stating that once the customer pays, then we will pour this cup into our tank. But until the customer doesn’t pay, unfortunately, you should not account that as money that has entered the business. The other end, money that flows out, each time a supplier or anyone else raise an invoice for you to pay on some delayed terms on credit, means they’ve brought a cup in front of you saying at the end of this month or in 30 day’s time, you have to fill up this cup for them.
That’s why it is so crucial for entrepreneurs to manage their businesses by controlling the amount of money that flows out and the amount of money that comes in.
How to manage money – strict payment terms!
When it comes to the money coming into the business, you have to be very strict on payment terms. Try not to allow your customers extended times and deferred payments. If you go out shopping, you have to pay before you leave the shop. Treat your company with respect and that should be the case with your customers. They should pay whenever they get the service. When it comes to the amount that flows out, going back to the P&L, the P&L will not show you items that are on higher purchase. That is an entry that comes off the balance sheet. But if this is getting confusing, don’t worry. The easiest way of looking at it is that any amount that needs to leave the company at the end of the month is the water that pours out.
How to manage money – money ‘in transit’
The next step is to understand that if you have all the amounts of money depicted as a bar that comes into your bank account, let’s say £100,000, then some of it will go straight to your suppliers.
This is money that is in transit only. You should not count this as money that is actually yours. This is only temporarily on your accounts and you will be soon paying your suppliers. But the thing worth noting is that the amount left here is the amount that is needed to pay all your bills. If this was let’s say £40,000, then the amount left is £60,000 and you have to make sure that what is left there covers everything that pours out there. Let’s say the company requires £50,000 to keep it running, in this case, you are making a £10,000 profit, but truly there should be more profits because whatever’s left here should cover your overheads, your expenses, and you should have an allowance for bit of profits.
How to manage money – cash is King
It’s important to understand that if we don’t spend the profit, our water levels will go up. And remember – cash is King – it’s good to have as much cash as you can. Obviously once you exceed some levels, it is better to reinvest so that your company continues to grow. Another thing worth looking at are the discounts we give to customers. If we have our salespeople handing out discounts, then the discount is detrimental to the business because you basically cut away from the bottom line.
If you hand out a 20% discount means that you are taking away from the business £20,000. Therefore, your new balance is not £60,000, it is £40,000. Therefore, you are making a loss because you need £50,000 to keep going, whereas you’ve only made £40,000.
What becomes obvious here, is that in order to still achieve a £60,000 profit, you have to increase your productivity, service or the amount of orders by 50% 0 because 50% of £40,000 is £20,000 so you would have to do 50% more. Imagine 50% more phone calls, more quoting, more items delivered, dispatched; everything multiplied by x1.5. It shows clearly how detrimental handing out bonuses is.
Simplifying the world is a good way to understand very complicated mechanism. Same with finances in any business – it’s much easier to treat money like water tank with an in-feed and an outfit and depending on where goes more, the level will go either up or down. Remember, that as a business owner, your role is to make sure that the water (money!) will always go up.