5 Cash Traps Every Trade Business Should Avoid

June 4, 2024 - Peter Wesley

The Nitty Gritty

  • Learn about the five common cash traps every trade business should avoid
  • Find out how to improve cash flow across multiple workflows and processes
  • Get ten top tips for adopting best practices for financial management
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Many of the business owners I’ve worked with over the years have asked me the same question - “I’m making a profit, BUT where is the cash?”

Effective cash management is not just a financial strategy; it’s a survival skill for every trade business. In this article, I will explore the common cash traps that impact the growth of contracting businesses.

If you can improve just three of these five CASH TRAPS, your bank balance WILL grow as your business grows.

The Importance of Cash Flow Management

Understanding and managing cash flow is crucial for the success and sustainability of any business. While profit is often seen as the ultimate goal, cash flow represents a company's actual lifeblood.

Profit is a matter of opinion - Cash is a matter of fact

Without sufficient cash flow, a business can quickly find itself in financial distress, regardless of its profitability on paper. That’s why the aim of this article is to shift the focus from mere profit tracking to comprehensive cash flow management, ensuring that trade businesses not only survive but thrive in even the most competitive markets.

5 CASH TRAPS:

1. Slow Work-In-Progress (WIP) Invoicing

Delays in invoicing for work-in-progress jobs can create significant cash flow challenges. The longer it takes to bill clients for completed work, the longer it takes to receive payment, which can strain a trade business's liquidity.

Strategies to Accelerate Invoicing:

  • Regularly Review WIP: Conduct weekly reviews of all ongoing projects to ensure timely invoicing
  • Streamline Invoicing Processes: Use job management software like Simpro to automate invoicing as soon as milestones are reached. Use the “Job Activity” report in Simpro to see your project spending and ensure you claim the correct amount.
  • Set Clear Payment Terms: Establish and communicate clear payment terms at the start of each project.
  • Ask for Deposits and Link Progress Payments To Outgoings: You will be surprised how often a customer will say yes when you simply explain why you need payment at a certain time - most customers are not thinking about your cash flow during their project.

2. Engaging in Low-Margin Projects

What you said YES or NO to a month ago will impact your profit margin today. Low-margin projects might keep your team busy, but they can significantly drain cash reserves. These projects often consume resources and time without providing adequate financial return, leading to cash shortages.

Remember, REVENUE IS EGO!

Strategies to Avoid Low-Margin Projects:

  • Conduct Thorough Project Analysis: Before taking on new projects, analyze the potential margins and ensure they meet your profitability criteria.
  • Focus on High-Value Clients: Target clients and projects that offer better margins and align with your business’s strengths.
  • Review Past Projects: Learn from previous projects by analyzing profitability and identifying trends to inform future decisions.

3. Collections and Tolerating Slow-Paying Customers

Slow-paying customers can cripple cash flow and create a cycle of financial stress. The longer it takes to collect payments, the harder it becomes to meet your own financial obligations.

Strategies to Improve Payment Collection:

  • The Accounts Receivable Number must be owned by someone operational. Don’t leave this to an accounts person to manage - it MUST be within operations.
  • Implement Stringent Credit Control Measures: Conduct credit checks on new clients and set credit limits based on their financial health.
  • Use Automated Follow-Ups: Tools like Xero, Chaser, or Debtor Daddy can automate reminder emails for overdue invoices.
  • Offer Early Payment Discounts: Encourage prompt payments by offering small discounts for early settlements.

4. Defects and Rework

Defects and reworks consume time and resources, inevitably burning through cash reserves. Addressing quality issues post-completion can lead to additional costs not accounted for in the original budget.

Strategies to Minimize Defects and Rework:

  • Invest in Quality Control: Implement stringent quality control processes to catch issues before they escalate.
  • Train Your Team: Regular training sessions can ensure that your team adheres to best practices and maintains high standards.
  • Measure Defects/Rework: Create a new Cost Centre or a Tag in Simpro. If a job needs revisiting after it is closed, then create a new Job with this new Cost Centre or Tag (I recommend calling it Defects) - all time and material go to the newly created ‘Defects’ Job. Review what is spent on rework and defects each month and always remember ‘what gets measured gets managed’.

5. Excessive Inventory

Inventory management is critical to maintaining healthy cash flow. Excessive inventory ties up cash that could be used for other essential business operations. Materials that sit on shelves for extended periods represent idle cash that is not contributing to the business's liquidity.

Strategies to Avoid Excessive Inventory:

  • Optimize Inventory Turnover: Regularly review your inventory levels and adjust orders based on actual usage patterns.
  • Implement Just-In-Time (JIT) Inventory Systems: This approach minimizes inventory holding costs by aligning orders with production schedules. Most suppliers will support you by holding what you need and only releasing and invoicing when required.
  • Use Inventory Management Software: Tools like Simpro can provide real-time insights into inventory levels, helping to make more informed decisions. But, remember Garbage In = Garbage Out. You need tight controls on your inventory, ensuring material is booked out to a job and regular stock takes are done.

Implementing Effective Cash Flow Management

Beyond identifying these cash traps, it's essential to implement practical measures to navigate these challenges effectively.

Step 1: Implement Efficient Accounting Systems

Having robust accounting software is foundational. Ensure your chart of accounts is set up correctly and that all bank feeds are activated for easier bank reconciliations. Software like Xero and QuickBooks can automate many processes, making cash flow management more straightforward.

Step 2: Regularly Review Financial Reports

Always review your Profit and Loss and Balance Sheet as regularly as possible. Monthly financial reviews are essential, but you should also have access to a weekly (and maybe even daily) view of your profitability. Understanding your gross profit, the difference between mark-up and margin, and the cost of sales allows you to make informed decisions.

Step 3: Monitor Debtors and Creditors

Keep an eye on what you owe and what is owed to you. Implement automatic follow-ups for overdue invoices. This ensures that cash flows into the business, reducing the risk of cash shortages. Assign someone in the business to manage this task and report on the business’s cash position each week.

Step 4: Understand Your Numbers

Dive deep into understanding material and labor costs and how they affect your gross margins. Educate your project managers on these numbers and hold them accountable. Job management systems like Simpro can show the Profit and Loss on each job and the projected Cost To Complete, as long as the system data is accurate.

Step 5: Forecast Cash Flow

Create a clear cash flow forecast to anticipate future financial needs. This involves projecting cash inflows and outflows over a specified period, allowing you to plan for potential shortfalls and make strategic decisions to maintain liquidity. Once you have clean books, great tools are available to help with this.

Conclusion

Managing cash flow in a trade business is not just about monitoring the cash in the bank. It’s about understanding the numbers, making informed decisions, and implementing efficient systems. Whether you're a seasoned owner or a young entrepreneur, mastering cash flow management is crucial for your business's success. Remember, the numbers are your true north; navigating the business landscape becomes significantly harder without them.

By avoiding these common cash traps and adopting best practices for financial management, trade businesses can secure a clearer financial picture, make smarter business decisions, and sustain long-term growth. In the competitive world of contracting, having a robust cash flow strategy is not just beneficial—it’s essential for survival and success.

PETER’S TOP TEN TIPS:

  1. Build a cash buffer that is three months of operating expenses in the business
  2. Make sure your bookkeeping is up to date - you MUST have accurate numbers
  3. Everyone in the business can affect Gross Profit - make sure everyone knows what their targets are and can see how they are tracking
  4. Reduce debt
  5. Don’t let your overheads creep up over time - spring clean every six months
  6. Know your break-even point each month/week
  7. Select the right sort of customer and the right sort of work
  8. If in doubt, hire an expert - a good financial manager will help you manage your cash
  9. If you are in a tight cash situation, someone in the business should monitor cash daily or at least weekly
  10. Educate yourself, and keep asking questions until you understand the numbers - if it feels wrong, it probably is, and you should keep digging

Learn how to manage your finances in just 1 hour a week with the Trade Business Finance System How to Guide: 3 Steps to Simple Finances for Trade Businesses

Book cover: 3 Steps to Simple Finances for Trade Contracting Businesses

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Author - Peter Wesley

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Peter Wesley founded Better Back Office in 2013 to help contracting businesses thrive by handling their bookkeeping and back-office operations. With a background in the Navy as an officer and navigator, followed by a career in finance and accounting, he developed a strong foundation in discipline and execution. His team of 15+ professionals, including CPAs, bookkeepers, and IT experts, ensures that trade businesses have more time, confidence in their numbers, and compliance. When not working, Peter enjoys sailing and mountain biking. His mission is to streamline operations for trade businesses, enabling them to make informed decisions and grow efficiently.