Understanding Your Cashflow

It might seem odd to suggest that we should understand our cash flow; how could we not understand it? It seems straightforward: money in from customers, money out on purchases and expenses and what’s left is profit.

But is it really that simple?

The Deposit Trap

While we can properly use all the money coming into our bank account, not all of it is ours. Deposits are unearned revenue (a liability) until the work is completed; only then do they become recognised as revenue. If the project doesn’t go ahead, that money must be repaid. Realistically, this rarely happens, and maximising the initial deposit we take on jobs is good for our cash flow and minimises the risk of bad debt.

However, deposit money can distort our view of the business, leading to bad decisions.

Flooring businesses quite rightly make use of deposits in the course of business. The risk is that deposits can mask our underlying profitability, or lack thereof. Without good financials, a flooring business can trade unprofitably for a long time, so long as it continues to make sales that generate cash from deposits.

Warren Buffett famously said, “Only when the tide goes out do you discover who’s been swimming naked”.

Real World Risks

We see the phenomenon of trading on deposits most often in the building industry: building companies often have a full book of forward work, but if they operate on a high-volume, low-margin model, the house of cards collapses when they experience a slowdown or a project goes badly wrong. They have been using client money as a second bank, and they don’t have the capital to continue trading if things go wrong.

Profitability varies from store to store, but the gross margin on flooring is generally 30-35%, and overhead often reduces it to a net profit of 10% or less. Flooring stores have risk spread across more customers than builders for significantly less money, but we can let deposits hide our underlying profitability.

Key Metrics to Monitor

Money in the bank is not necessarily an indicator of profitability, but it is one metric we need to monitor. There are others:

• The amount we carry in customer deposits from month to month

• The profitability of every job we install in the course of each month

• The profit we make each month

• The amount of work we have ahead of us in our pipeline

• Accounts receivable, especially those outside of agreed payment terms

• Retentions

Tracking Deposits

All deposits should be coded automatically to “Customer Deposits” in our financial management system. By doing so, we can quickly see how much these monies are funding our business. Dramatically more Customer Deposits in our business than the money we have in our bank accounts could indicate a problem.

Profitability

We should know our profitability month to month; ideally, by the 15th of this month, we should know last month's profitability.

But more than that, we should know the profitability of every individual job we have done in the month. Back-costing is a chore, but it shouldn’t be overly time-consuming. A good flooring specific system will automate much of this by linking purchase orders and installer invoices to jobs.

Pipeline

There are a number of components to a pipeline:

• Number and value of quotes issued in the last 30 days

• Conversion rates by number and value

• Confirmed sales awaiting installation

• Value of work booked for installation

Regularly monitoring our pipeline will give us a good sense of what each of these values should be if we are to continue trading well. Variations in these numbers should generate appropriate action on our part.

Accounts Receivable.

We need accounts receivable paid on time. If we let this get away on us, we will inevitably have a cash flow crisis. We need to pay particular attention to jobs that are subject to complaints. The longer it takes us to resolve issues, the less likely the account will be paid in full.

Retentions.

If we work on a project subject to retentions, the entire project's profit can be tied up in those retentions for months. Managing cash flow for a commercial flooring business is a subject in itself; suffice to say that retentions can adversely affect our cash flow. By regularly reviewing these metrics, we can spot issues early, make better decisions, and build a more resilient operation—rather than waiting for the 'tide to go out.'

Tools like RFMS can automate tracking of deposits, job costs, pipeline, and profitability reports, freeing owners to focus on growth. If you would like to see what RFMS might do for your business, we would be happy to meet with you.

Chris Ogden is a consultant and the Managing Director of RFMS Australasia (RFMSanz.com), a supplier of IT solutions for the flooring industry. Chris has an extensive background across all aspects of the flooring industry and can be contacted at cogden@RFMSanz.com.