Don’t Rob Peter To Pay Paul!
Steady cash flow is vital for any business but even more so if you’re an independent small business. After all, if you don’t have a steady cash flow, you can’t pay bills, employees or even yourself!
One of the biggest mistakes a business owner can make is “robbing Peter to pay Paul” … that is, taking monies that don’t belong to you and intended for specific purposes and using those monies for something else. The most common example is taking monies prepaid by a client intended for passthrough third-party costs and using those monies to cover your payroll or operating expenses.
For instance, you prebill a client for third-party costs associated with a client project. The client pays you the monies in advance with the intent that those monies are to be used to pay the third-party costs (ex: third-party vendor bills) on the client’s behalf. Your business is experiencing cash flow issues. You need cash immediately to pay rent or your upcoming payroll, so you use those client monies to pay your rent or payroll instead of using those monies for what they were intended for. As such, you robbed Peter (the client) to pay Paul (the landlord or payroll company).
While you might get away with it every now and then provided you replenish the funds before it’s time to pay the vendors (like a short-term bridge loan), this is a terrible habit and will get you into hot water especially if there comes a time when you can’t pay those third-party vendors and the vendors go knocking on the client’s door looking for payment; payment the client already prepaid to you to pay those same vendors. Besides simply a bad habit, you run the risk of losing your credibility and the business relationship with the client and it can lead to potential legal implications if the client decides to pursue such action.
Bottom line … DON’T ROB PETER TO PAY PAUL!
There are various steps you can take to help manage and maintain the financial health of your business and potentially mitigate cash flow issues including, but not limited to:
Working with an experienced Accounting/Financial professional who can help manage your business finances
Having a good Accounting/Finance system or solution to manage and track your business finances and not some makeshift solution!
Getting into the practice of preparing financial projections and cash flow projections to help track and monitor the financial health of the business on a monthly, annual and ongoing basis
Staying on top of your client billing, Accounts Receivable (A/R), collections and aging of those receivables
Routinely sending Open Invoices reports, reminders and Past Due notices to clients and following up with clients to ensure timely payment
Encouraging clients to remit payment electronically (ex: ACH) in lieu of paper checks
Clearly distinguishing between monies that are income to the business versus monies which are passthrough to the business. Passthrough monies should be earmarked. If necessary, you can establish a separate bank account to store passthrough monies especially if you deal with significant amounts of prepaid funds intended for passthrough costs
Maintaining a cash reserve to cover at least two to three months of business expenses (backup for a rainy day!)
Having a good new business strategy to ensure a steady flow of new business, new clients and additional sources/streams of income
These are just a handful of ways you can be proactive with the financial health of your business which can help mitigate potential financial risks and cash flow issues down the road.