The Month It Gets Tight

A business can be profitable for the year and run out of money in May. Owners who have not lived this find it hard to believe, and owners who have lived it never forget it. The annual profit figure says the business works. The May bank balance says the business cannot pay its people. Both are true, and the gap between them is timing, which is the one thing the roof never thinks about and the floor is built around.

Here is how it happens. Revenue is recognised when the work is done or the invoice is raised, but the cash arrives when the customer pays, which for a business selling to other businesses is thirty, sixty or ninety days later, and sometimes after a chase. Costs, on the other hand, leave on time. Salaries go on the last working day. Rent goes on the first. Software takes itself on the renewal date whether or not anyone remembers. The tax bill arrives on a date the government chose, with no interest in whether your largest customer has paid. So the money goes out on schedule and comes in when it feels like it, and in any month where several costs cluster and a few customers are slow, a profitable business is short.

There is a second version, which is growth. A business that is growing fast spends money on delivering work before it is paid for that work. The faster it grows, the wider the gap between what it has spent and what it has collected, and there is a speed at which a profitable, growing business runs out of cash entirely. I have watched this happen to companies with hundreds of staff, and the owner's face is always the same: how can we be going bust when we have never been busier?

The third version is seasonal. Nearly every business has a quiet month or two, and if the quiet months fall just after a tax date or just before a large payment, the year's lowest cash point is not an accident but a fixture, arriving on the same date every year and surprising the owner every time.

The response is to find the tight month in the model, now, and to treat it as a known event rather than a recurring shock.

Take the cash row of the model and look for the lowest point. If there are two, note both. Then ask what is causing it: late payment, growth, season, or a cluster of costs. Each has a different remedy and the model tells you which you are dealing with.

For late payment, the remedy is in the terms and the chasing. Invoice on the day the work is done, not at month end. Shorten terms for new customers. Ask for a deposit on anything large. Chase on the day the invoice falls due, not a fortnight later, because the customer who pays late is usually paying whoever asks first. None of this is unfriendly. It is a business behaving like a business.

For growth, the remedy is to see the gap coming and fund it deliberately. A facility agreed with the bank while the numbers are good, or a customer asked to pay in stages, or growth slowed for a quarter so that collection catches up with spending. The owner who can see the gap in the model gets to choose which. The owner who cannot gets to choose nothing.

For season, the remedy is to hold cash from the good months rather than spending it, and the model is what gives you the discipline to do that, because it shows you exactly which month the cash is being held for. A good month stops feeling like a windfall and starts feeling like what it is, which is the funding for March.

Whatever the cause, the tight month is a date, and a date can be prepared for. Tomorrow we build the third layer of the floor, the operating plan, which is how the model gets checked against the real world instead of filed.

Continue reading: What Gets Measured, by Whom, and When →

The session: The Nine Fears, and the floor underneath your business. Wednesday 2 December, 5pm UK, free →

Or start the diagnosis: Take the free 10-minute Entrepreneur Gap scan →

The book: The Science of Getting Rich and How to Apply It →