Having served as an advisor to over 100 companies, I can tell you that improving cash flow — and thereby, profits — is a major concern in almost every business. Yet many entrepreneurs are unaware of how things that drive cash flow affect their bottom line.
In the Entrepreneurial Operating System™ (EOS™) I teach companies to use, one of our sessions covers The 8 Cash Flow Drivers™. Many of these may seem obvious to you, but you’d be surprised how many entrepreneurs operate businesses without understanding them. If you don’t believe me, just watch an episode or two of a show like “Restaurant Impossible” on the Food Network, which frequently features business owners who have priced items at a loss because they haven’t properly accounted for what their cost is!
Here are the eight things that drive cash flow and profits, and what you can do to manage them.
Clearly, charging too little can cost you (big time!), but many entrepreneurs are so convinced that having the lowest prices is the only way to get business that they are frequently timid and hesitant to charge the going market rate, even if they’re providing a premium product or service. My clients are usually amazed when I tell them — and then show them — the difference. Across a vast number of transactions, charging a few cents more — literally pennies, nickels, and dimes — can mean the difference in having a $50,000 loss or a $200,000 profit.
2. Cost of Goods Sold (COGS) / Margin
COGS is what we pay for what we sell. Understanding gross margin — the difference between what we pay for an item and what we sell it for — is the number one lesson I ask my clients to learn because having a disciplined program to control this factor can do more to drive profits than anything else we do. One of my clients has identified six sub-components of C.O.G.S/margin and implemented what they call “The Big Six Program” to focus everyone’s attention on driving costs lower and margins higher. Again, over a vast number of transactions, a big difference is often made by pennies, nickles, and dimes.
3. Ancillary Sales
Very frequently overlooked are “add-ons” to the main products/services we sell. These seemingly small opportunities can yield huge profits! One retail chain I worked with made almost all their bottom line profit by selling warranties and product protection plans. Others gain huge margins by adding a second item for free and asking the customer to pay separate shipping and handling. Having someone focused on making sure every sales person is adding, where possible, ancillary sales can be a great cash flow and profit driver.
4. Service Time
Many businesses employ lots of people to provide services or install the products they well. Focusing on average service time, identifying the best practices of your best servicers, and regularly (at least monthly) spending time spreading these best practices to the rest of the team can pay big dividends. One company I worked with created “ABC Company University”. They grant “degrees” for completing training and offer boosted incentives to employees achieving top 25% performance rankings.
Mistakes are costly, and very few companies quantify exactly how costly they are. As an example, let’s say that just ONE mistake per day can waste two hours of someone’s time. At a loaded cost of $25 per hour, this is almost $12,000 per year! To prevent such expensive errors, “ABC Company University” requires a course called “Top Ten Errors To Avoid At All Costs!”, and has recognition programs for those who go months or years without an accident or serious mistake.
6. Compensation / Labor Costs
Second only to COGS as the top cost on the P&L statement is labor, which is typically half to one third of all costs. Benchmarking full-time equivalents and driving sales per employee, costs per employee, or some other metric to ensure your total labor costs are competitive is essential to driving this cost down. Assign one person to be the champion of lowering labor costs per unit produced or per service provided.
7. A/R Days
Accounts Receivable ratios can be calculated to “DSO” – the number of days sales outstanding. Keeping DSO as low as possible is essential to optimum cash flow. For example, a company may take an average of 40 days to collect on an invoice once billed. In a $12,000,000 annual revenue business, having a program to drive this to 30 days would add a one-time boost to cash flow of over $300,000! Doesn’t it make sense to have someone watching this number?
8. G&A Expenses
Almost everyone focuses on General and Administrative expenses, and of course they should. Having annual/monthly budgets by location or department and monitoring them on a monthly basis is the main way to drive this cost lower. And it’s such a basic thing that it amazes me how many companies do not do this!
I’ve been CFO (though I’m no longer in the CFO business) of companies as small as a million dollars in revenue to greater than $50 million. My experience has shown that companies with the highest and most consistent profits have a system in place that keeps them unified in their vision and in the disciplines that propel them toward achieving. I think EOS is the greatest of such systems – if I didn’t, I wouldn’t teach it.
In EOS, we have a creed that says, “You cannot build a great organization on multiple operating systems. You must choose ONE.” Whether you use EOS or some other system is up to you, but if you want to drive cash flows and profits higher, pick a system and commit your team to its execution.