People speak in code for a variety of reasons. Sometimes it is just quicker, kind of like saying “#3” instead of “Double cheeseburger with large fries”. Code can be used for privacy or to keep secrets, so only the privileged few know what you are talking about. Then there is the euphemistic code – lessening the impact of something dirty, shameful, or unpleasant. Remember those first diaper changes as a parent? Our kids were just too beautiful for plain talk! I propose that in business, the term “cash flow problems” fits squarely in category 3.
Borrowers and Cash Flow Problems
During my banking career, I found that the most common stated purpose of a loan request was “for cash flow purposes”. It was a code to be deciphered. I could usually safely assume that it ruled out things like equipment acquisition or a real estate purchase, but beyond that it had little value other than indicating that the borrower was out of cash. Kind of like telling your doctor, “it hurts”. It is just enough to establish urgency but begs a series of questions to establish the source of the pain. “For cash flow purposes” was really a self-prescription for more cash, but not a diagnosis as to why cash had run dry.
Of course, a lender must discern the nature of the borrowing need to properly evaluate risk. In my experience, cash-poor businesses tend to focus on collections of monies owed them as the root cause of their cash crunch. They flex to creative accounts payable management practices to keep their businesses in operation – stressful work. Collections can be a problem, but less likely with today’s wide range of payments products.
Decoding the Problem
My decoder ring says that “cash flow problems” means profitability issues, which is much more difficult work than collecting, and an embarrassment for many that they wish to euphemize. At Bizzics, we always probe profitability first when coaching in our Business Liquidity lane. Invoicing and collecting are important disciplines. But businesses cannot survive in the long run if they collect less from their clients than it costs to deliver.
Profitability is a function of pricing achieved, cost to produce, and sales volumes achieved in relation to overhead (fixed) expenses. Profitability presents as an algebra equation, but there is a certain level of art to the pricing and production equation that must be satisfied before the algebra can be done. Consider three major challenges that every entrepreneur must overcome to ensure a gross margin that will enable long-term growth.
Working on Volume Before Establishing Value
I view it as the “ego buzz” of entrepreneurship. Every entrepreneur dreams of wide adoption of their product or service. Most entrepreneurs complete a solid competitor analysis and conceptual pricing standards. Still, the primal surge toward volumes tempts business owners into discounts and expensive programs. Granted, some truly strategic relationships may be worth it. But the danger is that the inherent value of your offering is permanently diminished by widespread discounting and “promo” offers. Keep your marketing costs separate and only use price as a marketing tool when the related volumes are so substantial that it puts you in a scaling mode on costs.
Being Clear-Eyed About Differentiation – In the Minds of Customers
Pricing power, and ultimately gross margin management, is mostly dependent on clear differentiation. You have built “uniques” into your product or delivery of the product that limit the availability of substitutes. Often, the emotional entrepreneurial run-up to market can cloud the distinction between cosmetic product differences and core “uniques”. It is the “unique” for which customers will pay a premium price. Signage and logos will not get you premium pricing, only something distinctly different for the clientele you desire to serve.
It is fairly easy to get in front of some sample of your target market and test these differentiators and your price point. People love to know about new stuff and how it can benefit them. Yet, people often overlook this important step because they love their product so much that they cannot stand the heartbreak of hearing it is a dud. Get over it. I guarantee you that your client wants something better than they have now, and they will gladly tell you how to do it if you give them the chance.
Prototype Costing vs Full Volume Costing – How Long is Your Runway?
New business formation is predicated on all kinds of assumptions, and the variable cost of producing your product is one of them. I have seen many, many cases in which business founders have based their variable cost assumptions on full-volume sales forecasts. But everyone knows that things cost less when you buy in bulk. And there is no guarantee of how long it will take you to achieve full sales volumes. In the meantime, you buy in smaller lots, paying 20-25% more (or even more than that in some cases) your margin gets pinched. You may lose money on every single sale. Be conservative and realistic on the costing side.
Banks enjoy working with clients with good growth stories and solid profit fundamentals. There is usually a way to extend credit for temporary or seasonal collection issues. Funding operating losses is not very attractive to any funding source. Fixing profitability problems is no way an embarrassment, however. It is part of the normal course of business. It is just something that you need to figure out before asking for more cash. As the great leadership guru Max Depree once said, the first responsibility of any leader is to define reality.
