Cash Needs Should Drive Revenue Goals

Originally published: 04.01.12 by Ruth King


"Catching up" and relying on credit are unreliable financial practices.

Without profits, cash runs out. Yet, your business could have an unprofitable month or quarter and still survive. Many contractors that operate with Dec. 31s as their year-end, state that the first quarter always is unprofitable. They spend the next nine months catching up — just so they can have another unprofitable quarter the next year. They go from a healthy bank balance on Dec. 31s to almost no cash by March 31. They pray for a “hot summer” rebuild the cash balance.

 Does this revenue-and-cash rollercoaster make sense? No. However, as I hear often from contractors and other business people, “It’s the way it’s always been!”

What if you could do something about it? What if you could have a profitable first quarter so you weren’t always behind? What if you didn’t have the cash-flow stress for nine months to make up for first quarter losses?

Common thinking is to use lines of credit as a solution. In this age of banking uncertainty, stronger regulations, and ever-changing policy decisions, are you sure that your banker and your bank’s policies will remain constant so that your line of credit terms don’t change? Are you sure your bank won’t decide to get rid of all construction loans and “call your loan,” forcing you to repay it within 30 to 90 days? It’s much better to rely on an internal line of credit, one that you generate through positive profits and cash flow.

Every business wants to avoid this situation. So how do you determine how much revenue you actually need to be financially healthy in the first (or any) quarter? The crucial measure is cash.

If your bank balance usually is $100,000 on Dec. 31, and it is $10,000 on March 31 —assuming you want to keep $100,000 in your bank at all times — you need $90,000 cash to cover an unprofitable first quarter.

Remember that profits are not cash. You need $90,000 divided by the percentage of your profits that get turned into cash within 30 days. If you turn 90% of your profits into cash within 30 days, the amount of profit you need is $90,000/0.9 or $100,000 in profit.

Then look at the overhead segment of your profit-and-loss statement. Add the overhead for the 90-day period with two changes. Add all of the cash expenses not covered in overhead and subtract all the non-cash expenses covered in overhead. For example, your loan payment might be $1,000 per month. The only part of that $1,000 that is covered in overhead is the interest expense. The principal repayment is a balance-sheet transaction, which is not considered overhead. However, from a cash perspective, you must count all $1,000 because it is cash that is depleting your bank account.

On the other hand, you might have a depreciation expense each month. This is a non-cash expense and should be added back to the overhead expenses.

Assume that your profit-and-loss statement states:

1. Cash collections for the three-month period must be $100,000.

2. Overhead is $150,000 for the three-month period.

3. Loan interest expense is $2,000 for the three-month period.

4. Total loan payments are $12,000 for the three-month period.

5. Depreciation and other non-cash expenses are $5,000 for the three-month period.

Cash needs:

$100,000 + $150,000 - $2,000 + $12,000 + $5,000 = $265,000.

Assuming that your company’s gross margin is 40%, you need revenues of $265,000/40% or $662,500 in this three-month period. 

Even if your company has never generated $662,500 in the first three months of the year, you can make this happen: Create a contest, explain to your employees why this needs to happen, and ask for suggestions; or, contact your maintenance agreement customers and give them a reason to buy; or implement any other creative idea.

Determine the amount of cash you need in the bank at all times then calculate the revenues needed to make this happen. Involve everyone in your company in this goal, and it probably can happen.

 

 

 


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