Our team at Palo Alto Software talks with thousands of small business owners across the country every year. Recently, we chatted with one founder who told us that one of her greatest business insights lately is that she needs to spend money to make money.
It makes sense, on a certain level, but it’s a little counter-intuitive if you’re used to managing your own finances, where the mantra is “save, save, save” to get ahead.
In business, especially if you’re trying to grow, most of the time there’s no way around it. You need to spend—but you want to make those decisions having carefully weighed the consequences against the opportunity.
Brunson (one of our own software engineers) and his wife Karen run a local specialty yarn shop called Cozy. This year, they’ve been thinking about whether it’s time to bring on their first employee so they can really take some time off this summer—for the first time since they started the business. They’re trying to figure out whether they have the sustainable revenue and cash flow they need to make it work.
Bringing on your first employee is a significant milestone, and Brunson and Karen want to get it right. They want to treat a potential employee well, and they don’t want to introduce unnecessary stress around paying their bills and meeting payroll.
These two ideas are connected. You need to spend money to make money in business, and having a firm grip on your cash flow—how long it takes to get paid, seasonality considerations, etc—impacts your ability to make those significant financial business decisions.
Small business owners tell us that they want to be able to make major financial decisions with more confidence. They’re exploring things like:
- Can I afford to hire a new employee right now?
- Why don’t I have enough money in the bank to pay all my bills? I have been doing a ton more business!
- Do I have enough cash to buy a new piece of machinery?
- Is this the right time to expand?
- I want to launch a new, big marketing plan. What can I afford to spend?
So what can you do to ensure that you’re making smart business decisions? Start with understanding your cash flow.
What you need to know about cash flow to make major financial decisions
Here are three tips for making better financial decisions for your business.
1. It’s not cash until you actually get it
Your company can be generating a ton of revenue, but unless your customers are actually paying their invoices, you don’t have cash in the bank to pay bills. You can be a profitable business on paper and still go under if there’s too much of a lull between when you do the work or provide the product, and when you get paid.
2. Do a cash flow forecast and compare it to your actuals regularly
Use your accounting software if you have one. If you’re making major financial decisions like hiring or taking on debt to fund your growth, consider upgrading from an excel spreadsheet. You need to have a clear understanding of where your cash is, and where it is projected to be to help make good spending decisions.
Build a cash flow forecast. If you have a sense of when you’re going to be paid for a big job, or if you know that you’re going to sell a lot of product to a major buyer and wait three months to get paid, factor that into your forecast. The more you can build into your forecasting model, based on actual data from your business, the better your cash flow forecast will be.
Set a regular time each month to review your financials and the rest of your business strategy. We call it Lean Planning. The most important part is making sure you’re never surprised that you don’t have money in the bank to cover payroll or bills. If you can see a dip in cash flow six months out, it’s going to be a lot easier to get a line of credit now than in six months when you’re actually short on cash.
3. Model a few different financial scenarios to understand the impact
After you have built out your strategic forecast and used your actual results to help predict your revenue, expenses, and cash flow, you will want to think through some “what if” scenarios:
- What if you get that big purchase order from the retailer? Do you have the cash to build your product and ship it before getting paid?
- What if you bring on the extra sales manager to help you sell more? Can you afford their salary as they build their pipeline of sales?
- What if you buy the equipment you need to help produce more sales? Can you afford to buy the equipment with the cash you have now, without jeopardizing future cash flow?
Modeling some scenarios using a tool like LivePlan can help you plan and understand how fast you can grow, and what spending decisions you can make. Taking some time to model some what-if scenarios can help you figure out the timing of your spending decisions, and how they will impact the financial health of your business.
Whether your immediate goals are scaling a company so it can be acquired or bringing on that first employee, the key to making better financial decisions is to use what you know: your own financial information.
No one knows your business better than you. Yes, you have to spend money to make money, but you reduce the risk associated with a major spend if you’ve planned for it and understand what your business will need to be able to do to support that decision.