The symptoms of disorganized cash distributions (and how to correct them)
Small business cash flow is an incredibly complex topic with lots of nuances. Every single aspect of your business impacts your cash flow. That’s what makes rooting out the core cause of your cash flow issues and fixing them such a difficult process. It can take months of trial and error to find every single thing that’s hurting your cash flow. And, once you go through all the typical big business best practices (eg, streamlining your invoicing, improving your profitability, building savings, getting a credit line, etc), you need to look at your business through a small business lense and focus on the small business issues that big business best practices frequently miss.
The biggest small business-specific cash flow problem is cash distribution (aka paying the business owners). Cash distribution just isn’t an issue in big business. Any remaining profit after paying all the operating expenses (aka the expenses required to run the business) just sits in retained earnings (aka accounting-talk for remaining profit after everythinggg) or is maybeee paid out as a shareholder dividend. Big businesses don’t have a solitary owner (or, handful of partners) whose living wages are dependent on taking distributions. And, that creates a very different dynamic. While you have to distribute money to pay your living expenses, big businesses get to stockpile it away in savings. If you only follow big business best practices, cash distribution will fly under the radar. But, just like you need to plan all your other expenses and cash outflows, you need to plan your cash distributions. And, not planning it creates its own slew of cash flow symptoms that’re ever so slightly different than big business cash flow problems and don’t have the typical symptoms or pain points. They have their own unique issues.
Lots of profit but no money :
Your profit (as shown by your Profit & Loss) and what’s left in the bank at the end of the month (aka what you thinkkk your profit is) will almost never match up. That comes down to a bunch of boring accounting reasons like certain cash inflows and outflows not appearing on your Profit & Loss or timing issues. (Check out this past issue to learn more about the different meanings of ‘profit’.) But, even if you ignore all that, there should still be money in the bank. Constantly scraping by, non-sufficient funds, bounced checks, and no business savings are symptoms of either not being truly profitable because you didn’t include overhead in your pricing or draining your business bank account into your personal bank account whenever there’s an extra $100 in it.
How to solve it: Stop draining every red cent out of your business accounts. Build up a cash cushion (1-3 months of operating expenses). If you’re having difficulty with that, take a hard look at either your profitability or personal finances.
Personal finance issues:
Businesses without a good cash distribution plan typically aren’t paying the owners a regular living wage (either thru salary, draws, or whatever your legal entity requires). When you aren’t paying a consistent salary to budget around, you’ll start running into personal finance issues which leads to putting expenses on the business credit card or sporadically pulling $20 here or there from the business operating account. This quietly drains your business’s bank accounts, hamstrings your growth, and can lead to a death by a thousand cuts.
How to solve it: Pay yourself a living wage and stop using your business card for personal expenses. This may require getting your personal finances in check.
The never-ending tax debt:
When you don’t plan for taxes, you’ll frequently end up with massive tax bills during tax season which require installment agreements and monthly payments to pay off. But, tax debt is tricky because to pay it off, you need to accrue more. For example, to pay off your income tax debt, you need to earn more money which, in turn, is taxed and accrues more income tax. This traps business owners in a constant cycle of installment agreements with variable interest rates (starting at 3-7%) and late payment penalties which create their own cash drain. Not to mention the stress of constantly owing the IRS.
How to solve it: Get your most recent tax debts into an installment agreement, make those payments, and start making those estimated quarterly payments. Even if you can only make partial quarterly payments, it puts you in a better place next year. Depending on how large your tax debt is, this might take a few years to dig out of because you’re effectively paying double the tax (last year’s and this year’s) at the same time.
Overcompensating with massive cash reserves:
Other business owners get burned by the massive tax bill and overcompensate by saving wayyy too much. They aren’t saving a cash cushion, an emergency fund, or a war chest. It’s a just huge amount of money specifically set aside to deal with taxes. While there’s nothing inherently dangerous about huge savings, it isss inefficient. That money could be invested into your business, contributed to retirement plans, or distributed to you.
How to solve it: Talk to your accountant and get proper quarterly tax estimates. They’ll probably give you what’s called ‘safe-harbor estimates’ that’ll make sure you avoid underpayment penalties. These might leave you owing at year-end tho. So, if you’re having an exceptionally good (or bad) year, mention it to them and ask how much you should change your estimates to compensate.
General cash stress :
This is not an all-encompassing list of symptoms. The pain points can manifest in all sorts of different ways and vary greatly depending on your business and personal finances. But, they all create a unique kind of stress and anxiety at the point where your business finances meet your personal finances. If you feel like you’re doing everything correctly and are paying all your operating expenses on time with plenty of money to spare, but you’re still struggling to take money out of the business, with your personal finances, or paying taxes – it might be a cash distribution problem. (It could also be a few other things, like a personal finance problem where you’re living outside your means. Like I said earlier, cash flow is incredibly complex.)
Action Item:
Implement a cash distribution system (Check out this past issue for the basics or my new mini-course for a more in-depth look). Then, add in each specific problems action item from above.