I frequently cross the Potomac River north of Washington DC. Recently, as I sat directly above the Potomac waiting for traffic to start moving, it occurred to me that just as the river feeds the Chesapeake Bay with water, a river of money to keep your business fed.
The sad reality is that the #1 cause of business failure is the owner taking their eye off the cash flow and assuming that given sufficient business, “everything will be fine.”
Years ago, a friend of mine told me how he had 10x’d a business from a start-up that generated $83k the first year to over $900k just 39 months later. Best of all, he took a $120,000 salary and there was $120,000 in pre-tax profit. Then he went on to admit that he nearly bankrupted the company while doing it.
“How could that be?” was my initial thought. You have a good salary and a profit. So I asked him to explain.
The business serviced the automotive aftermarket niche. And, it turned out that the business had both a B2C component and a B2B component. On the B2C side, it was growing but not as quickly as he would have liked. My friend determined that the way to scale was to provide his service directly to dealerships.
It's important at this juncture to understand the numbers. The product my friend sold had a retail price of $495 and after cost-of-goods (materials and labor) left a gross profit of just over $200. So, a 40% margin – not fantastic but decent.
But selling to dealerships meant that he’d have to create a “wholesale” price as the dealerships wanted to make a profit as well.
And here’s where he made the critical mistake.
Instead of raising the retail price and selling to the dealership at a wholesale price that was the same as the former $495 retail, they gave the dealership a 20% discount. But, all you need to do is look at the math and you’ll see that he cut his gross margin in HALF from $200 to $100. Now with enough volume, to compensate for the loss of cash flow (just like slowing the flow of water in the river) this might have been ok.
But there was a second problem that compounded the cash flow problem that had gone unseen.
Retail customers pay for their product at delivery. So no waiting for payment. Dealership – and in particular car dealerships – are notorious for making their supplier wait to get paid and, in the case of my friend, that meant 45 to 60 days, if not longer.
With enough retained earnings, this might be a storm you could weather, but this company was only 30 months old – there weren’t sufficient retained earnings and very quickly, his “profitable” company couldn’t pay its bill and was even in jeopardy of missing payrolls.
The river – cash flow – had completely dried up.
Difficult choices had to be made…
Come clean with the dealership owners and ask them to help out OR put them on C.O.D. and risk getting them upset and sending the business elsewhere.
Refocus back on retail and institute a system of upsells to generate more cash.
Negotiate better supplier terms and use the cash from retail sales to refloat the company.
I’m happy to report, it worked.
By negotiating better payment terms from his dealership customers cash flow sped up. Refocusing on retail increased available cash and sped up receipts. Negotiating better terms with supplies meant the money stayed in his account longer (cash reservoir).
His 'Business’s River Of Money' was flowing again and this time, the river flowed with speed and economy.
Your Business’s River Of Money should do the same.
If you'd like Parthiv to help set the flow of your river, click below.
