As small businesses battle rising costs of fuel, goods, and labor, maintaining profitability can be an ongoing challenging. Inflation is at its highest in 40 years, with the Consumer Price Index (CPI) at 8.5% in July. Moreover, food prices have surged 13.1% over last year, leading consumers to cut back their spending on many non-essentials. For small business owners, the task of setting competitive prices while covering costs and maintaining cash flow can be tricky.
The value of a business is tied to its ability to maintain healthy cash flow and generate sales. Cash flow is a snapshot of normal business operations. If a business has more flowing out than it does coming in, there is a problem. In fact, a lack of cash is the top reason most small businesses fail.
Business owners can take the following steps to maintain healthy cash flow and further protect their business value.
Analyze Key Financial Statements and Identify Opportunities for Improvement
Your financial statements should be reviewed on a regular basis to monitor the performance of your business. Sales may seem steady, but are customers paying their invoices on time? You may have enough cash on hand to cover costs, but are you improving performance? A successful business should be growing in revenue over time.
Conduct a Cash Flow Analysis. Start by preparing your cash flow statement, which shows you how much cash is flowing into your business and how much is flowing out within a given timeframe.
- Review operating activities cash flow, including money from accounts receivables, money paid to suppliers, payroll, taxes not related to investing, plus depreciation of business assets.
- Review financial activities cash flow, including funds used for making payments on business loans, issuing stock to shareholders, or other financial obligations.
- Review investment activities cash flow, including money spend to purchase or sell assets not related to regular business operations, such as business equipment, machinery, real estate.
Tips to Increase Cash Flow:
- Optimize accounts receivables. Follow up with unpaid invoices. Create payment plans with late paying customers. Create incentives for customers to pay on-time and penalties when late.
- Check accounts payable terms to see if you have a grace period for delaying payments. Consider revising your terms.
- Reduce expenses. Look for ways to eliminate any unnecessary spending. Renegotiate prices with vendors or shop for less expensive alternatives.
- Reassess inventory needs. Buy less if you are stocked up or look for better bulk rates if necessary.
- Reassess prices. Look for areas with room to increase margins or raise rates on high-demand specialty services only you can offer. Also utilize competitive research to see how your prices stack up against others in your industry.
- Lower supply chain risks by diversifying suppliers. Alternative vendors can also increase your options for better pricing and availability.
- Consider a small business line of credit to preserve cash flow.
Conduct a Profit and Loss Analysis. Your profit and loss statement (or income statement) shows revenue, costs and expenses incurred within a given timeframe. Is your business generating as much profit as it should be? Are you missing out on opportunities to generate additional sales?
- Review sales over time. Identify any peaks or patterns you may be able to duplicate. Perhaps a past marketing campaign was successful in increasing revenue per customer.
- Review sources of income. Identify sources that are profitable and worth expanding, as well as sources with lower margins that deserve less time and resources.
- Review seasonality patterns. Identifying seasons when demand is either high or low can help your price, production, inventory, or even staffing strategy.
- Review cost of goods sold. Typically, your revenue should go up as your cost of goods goes up. If this is not the case, there may be a red flag.
- Review net income and profit margin. Your net income percentage (profit margin) can be used as a baseline across different time periods, as well as a comparison with your industry. To calculate profit margin, divide net income by net revenue and multiply by 100.
Estimate the Value of Your Business and Create an Exit Plan
Protecting the value of your business begins with knowing how much your business is worth. Not only is a business valuation important for long-term planning or selling your business, but also for determining growth strategies, obtaining financing, attracting investors, and more.
As inflation continues to be an issue for small businesses owners, many who are still recovering from the pandemic, requests for business valuations are on the rise. This is especially true for those aching to retire and facing the dilemma of whether to sell now or wait until inflation dies down and sales pick up. Business brokers are reporting an uptick in requests for business valuations.
"We are experiencing an uptick in business valuation requests which may translate into an increased number of owners deciding to sell," says Robert Flynn of United Business Brokers Group. "The counter point is that many owners who just weathered the Covid era, with all its problems, do not want to sell at what they perceive might be a depressed valuation. Owners are getting business valuations to assess their options," .
When it comes time to do a formal business valuation, owners should work with a professional credentialed appraiser. Oftentimes, this may be a professional business broker who can also give you an overall assessment of your business. For gauging an estimating value, earnings multiples or comparables methods can also be used.
Don't Expect Inflation to Go Away, Instead Be Creative and Innovative
While recent CPI data shows inflation may have peaked, it is likely to remain elevated for some time as supply chain issues persist and the Ukraine war continues to put pressure on energy and food prices. That said, reviewing your financials and conducting a business valuation can help you develop a gameplan going forward. You may even uncover some golden business opportunities.