Are you running out of money before you run out of money in your Operating Expense (OPEX) account? If this is not a one-off thing, you need to make some sort of adjustment so your Profit First Cash Management System (PFCMS) is functioning properly.
And this is where our (PFCMS) truly shines. Running out of OPEX funds is a red flag that your business may be operating beyond its means. It forces you to make tough but necessary decisions, such as cutting unnecessary expenses, renegotiating terms with vendors, or finding more efficient ways to operate. It’s a built-in safeguard that keeps your business lean and focused on profitability.
Any time you are not able to pay your bills from any of your allocation accounts as you should we call this a “pain” signal. In your body pain is a signal that your brain sends you telling you that something is not right in your body – it is a warning that if you don’t take immediate action something really bad might happen. If you put your hand on a hot stovetop it starts to burn, and your brain sends you an urgent message to tell you to move your hand quickly. When implementing Profit First we need to pay attention to these pain signals so that we can react quickly and properly to situations.
It can only be due to one of three causes:
- There is a blockage in receiving funds from customers
- You are overspending
- Your allocation percentages are off
There is no other option. Overspending means spending more than your business has received!
The first thing is to identify what has caused the problem. If you are new to Profit First then it is likely that this is a historical debt that predates your allocations and we need to fund this from your profit reserve account. But if not, then something more sinister is likely happening.
Consider the following possible causes:
- A seasonal expense – fund from your profit account and set up an allocation account to save for this expenses throughout the year
- A slow down in customers paying you – urgently look at your receivables and chase down slow payers. Review your terms of trade.
- A drop in sales – fund from your profit account; if this a seasonal dip then we should consider a drip account system to help manage; if this is not seasonal then we should review and cut expenses to adjust to your new reality.
- A change in expense types – we need to review your allocations so that the funds are in the right bucket.
This also gives you the opportunity of looking at your breakeven point in the business. You can use your Gross Profit % ([sales – cost of goods sold] divided by total sales) to calculate how much additional sales are needed to generate enough cash flow and meet your financial targets (including having enough funds available in your OPEX account). Let’s say that you’re $10,000 short, and your Gross Profit is 40%. By dividing the shortfall by your GP% (10000 / 0.4 = $25,000) you learn how much extra revenue you need to generate to make up for this shortfall. Keep in mind that this is just to break even – and we are not in business to simply break even. If you divide again by your OPEX allocation percentage then we now have the real number that you need to earn (e.g., if your OPEX allocation was 40% of Real Revenue, then we would calculate 25000 / 0.4 = 62,500). This is how much sales you need to generate to be able to pay those operating expenses AND your taxes, owners’ pay and profit goals.
Implementing our PFCMS isn’t just about making more money; it’s about building a business that’s financially healthy and resilient. It’s a strategy that ensures your business can weather the storms and continue to grow, all while keeping profit at the forefront of your financial decisions.
As Profit First experts, you can contact us anytime for coaching to help make your cash flow work for you, instead of you working for your cash flow.
