Cash is King
By Barbara Johnson
(This article first appeared in BeautyNZ Magazine January/February 2008. Updated August 2011)
Cash flow management is the most important business skill you need. No cash = no business.
The beauty industry is almost unique in that operators receive money from their clients before they have to pay their suppliers. If all the sales income is spent the result is cash problems! There is no guaranteed money coming in once today’s clients have walked out the door.
For salons, cashflow management is about making wise and consistent purchasing decisions.
As an accountant, there is one question I hear from clients that demonstrates they don’t understand how cash works: “If I am making as much profit as you tell me, why don’t I have any money in the bank?”
The answer is that, in the absence of personal overspending, the money has gone on payments which have drained the cash away.
You need a cash buffer in reserve. This means you need to manage and preserve your cash.
How big should my cash buffer be?
As a rule of thumb, you should aim to have enough cash or overdraft allowance to cover two months’ worth of business costs.
How can I preserve my cash?
There are three ways:
- Purchasing product and other sales stock
You need product to make that extra sale after the treatment, but don’t let persuasive sales reps tempt you to buy stock before you need it if that “great buy” is going to shrink your cash reserves. Can you really afford to take up that discount for early payment or bulk purchase? Think about your sales stock as cash sitting on the shelf.
- Purchasing equipment
Specialist treatment equipment can be a real earner, and you need it to match or beat your competition, but buying it outright will eat up a lot of your cash. Think about these three options to pay for capital expenditure:
Hiring – you pay a much smaller, regular amount for the use of the equipment, rather than one big outlay before it has started paying for itself. At the end of the hire term, you hand the machine back and start a new arrangement for new treatment equipment.
Buying on lease or HP – at the end of the finance period, depending on the finance type, you can buy the machine at a reduced cost, or own it outright.
Matching the length of the finance to the “life” of the asset – for example, five-year finance for equipment, 10-year finance for salon fitout on premises leased for 10 years. Bank finance is usually the cheapest option. (Cars are a separate issue which will be discussed in a future article).
- Using “free” credit
Free credit can be very useful if managed properly, but there are traps for the unwary. When the interest free period ends, high interest charges kick in and they can kill you profit and your cashflow.
Credit cards. Use the “55 days interest free” and pay the full amount when it is due to avoid high interest charges.
Extended interest free periods. Save a regular amount during the interest free period so you can afford to pay off the whole debt just before it ends. Otherwise you will be stuck with a horrendous interest rate and few early payment options.
Discount for early payment. Compare the discount you are offered, to the interest rate you would be paying on your overdraft.
Paying your own creditors late. While this is also “interest-free”, be careful about using your suppliers’ money. You may damage your reputation and credibility in the industry if you always pay late, and will run into serious trouble if you have a lean spell in your own business.
Planning for bills and expenses
Know your business and plan for when expenses need to be paid. Put cash aside to pay your bills and expenses when they are due.
Remember to plan for “irregular” expenses like GST, PAYE and other taxes. Work with your accountant to plan for these larger payments.
Watch your overheads and wages bills. Compare costs month-to-month and year-to-year to check that costs are not getting out of control.
Cash is King because it is only when you actually receive cash that you can pay your bills and have money to live on. Aim to collect the cash from your sales as you make them – don’t give credit. Only pay bills and suppliers when they are due. Be prepared for those times when sales fluctuate, usually with no warning.
Oborn & Johnson is a friendly, down to earth company, located in Takapuna, North Shore City. We have been specialising in accounting, tax and related services to businesses, investors, trusts and individuals, for over 35 years.