Episode 2 - Cashflow
Introduction
Welcome to the 255, where we help business owners like you unlock the full potential of your business through practical strategies and clear guidance. I'm Arnold Shields and I'll be your host as we explore a powerful framework that helps you make smarter decisions and maximise profitability and build long term value.
In this podcast series, we'll be breaking down a framework I call The 255, which stands for two fundamentals, five multipliers and five foundation stones that form the basis of a thriving business.
Whether you're just starting out or managing an established company, this framework is practical and actionable. It's designed to help you make smarter decisions and achieve greater profitability step by step.
In the last episode, I discussed the basics of the 255 framework, which are two fundamentals: cash flow and risk. These are the core of every business decision you make.
The 255 Framework Components
Then there are five multipliers—leads, conversion rate, average dollar sale, contribution margin, and valuation multiple—which form the business formula to skyrocket your growth. Finally, the five foundation stones which put your decisions into action.
What is Cashflow
Today we're going to discuss the first fundamental which is cash flow. Cash flow will determine whether you buy a new car or new house or you're selling your new car or house.
Cash flow determines the winners and losers in the business. Businesses with strong cash flow are the winners. They can pay better, attract top talent, and take advantage of new opportunities proactively. They grow faster with less risk, can borrow at lower interest rates, and provide owners with higher dividends and salaries. Plus, they experience far less stress.
On the flip side, businesses with poor cash flow are always in survival mode. They can’t act on new opportunities because they’re struggling to stay afloat. They have to take on riskier projects to try and generate cash flow, face challenges getting bank loans, and often resort to high-interest loans. They grow slowly and have little money available for the owners. It’s important to remember that a profitable business can still fail because of cash flow issues; it’s all about how quickly profits convert into cash.
Understanding Cash Flow Timing
Let’s look at a couple of examples. Imagine a consultancy business that invoices clients for services. The sale and profit are recorded at the time the invoice is issued, but if clients take two months to pay, there’s a gap between profit and cash flow.
In a product-based business, it can work similarly. Suppose a company anticipates a strong fourth quarter and buys 10,000 units. Even if they only sell 5,000, they still have to pay for the remaining 5,000 units. This difference between profit and cash flow emphasizes the need to efficiently manage balance sheet items and optimize cash flow.
Drivers of Cashflow
There are a few major drivers of cash flow. The first is your growth rate. The faster you grow, the more cash your business needs, since there’s often a lag between starting a job or ordering products and getting paid. On the flip side, slower growth requires less cash, and sometimes even reducing sales temporarily can improve cash flow by letting the business catch up.
Another key driver is the contribution margin. Businesses with higher contribution margins generate more cash and can grow faster, whereas low-margin businesses have less cash to work with.
A low contribution margin business that is growing quickly will always need extra funds either as owners capital injection or external lending. They always think that when the business gets a bit bigger when they reach $1m in sales, $5m in sales, $10m in sales - that they will be able to pay the money back, but they never pay it back, they just need more and more money. That is the way their business is structured. They are profitable but their cashflow never catches up to their growth.
The third key driver of cash flow is the efficiency of the balance sheet. The faster you can move items like inventory, receivables, and work in progress, the more efficient your operations become. This efficiency directly impacts how much cash the business generates and how quickly it can grow. For example, can you run the same business with lower accounts receivable by getting paid upfront instead of waiting 30 days? Shortening payment terms can make a big difference, as can reducing inventory cycles. Rather than holding six months' worth of inventory, could you adjust your buying and payment strategies to maintain less stock and still operate smoothly?
By increasing balance sheet efficiency, even businesses with high volume and low margins can achieve growth. But to make that happen, a highly efficient balance sheet is crucial. You need to have efficient payment terms. You've got to have efficient inventory cycles and supply chains.
In fact, a well-managed balance sheet can help offset the cash flow limitations of a low-margin business. For many low-margin, high-volume businesses, an efficient supply chain is essential for survival, the only way that the y can offset their growth and low margins is through the efficiency of their balance sheet getting the inventory on long payment terms and turning over the inventory as quickly as possible.
Avoiding the Borrowing Trap
Many business owners assume that borrowing is the only way to fund growth, often turning to expensive forms of finance like debtor or inventory financing because it’s easy to obtain. But this approach doesn’t address underlying cash flow weaknesses.
Instead of borrowing more, these businesses could change their operations to improve cash flow. Temporarily slowing growth, increasing asset turnover frequency, or raising prices can all help cash flow catch up. Understanding your cash flow dynamics is essential.
Adjusting Cash Flow in a Growing Business
When sales increase, it’s essential to understand how much extra cash is required to support that growth. For instance, what happens if you increase your prices or reduce PPC advertising? Sales might drop, but profitability and cash flow could improve.
In a service business, there’s often a “lockup period”—the time between starting a job and getting paid. Take a pest control service as an example: the technician might complete the job, wait a week to return and check, and then send an invoice two weeks later. That’s a lockup period of around four weeks. By using systems like Xero to invoice immediately and having a mobile payment option, they could reduce that period.
For lawyers and accountants, this lockup period is often much longer. A job might take six to eight weeks to complete, and then the client pays 60 days later—meaning the business might wait five or six months to get paid, all while covering wages, rent, and other expenses. Changing payment terms, such as requiring an upfront retainer and billing weekly, can significantly improve cash flow.
Organic vs. Structural Cash Flow
The cash flow generated from regular business operations is called operational or organic cash flow. If there’s a shortfall in organic cash flow, it may need to be supplemented by borrowing or equity investments. It’s critical to understand how cash flows within your business and to build a cash flow model to see how changes in sales, margins, or inventory affect cash flow. Many business owners don’t make a cash flow budget, not because they don’t care, but because it seems too complicated or they’re unsure how to do it.
For our businesses, we develop a long term cashflow model, with the key assumptions of our business. We will then try and break it. And by break it I mean how far can we push the assumptions before we run out of money. If sales increase by 100%, if we launch 10 new products, how much money can we take out of the business. When is the quarter that is the lowest cashflow month. For our eCommerce business, that is 3rd quarter, when we build up our inventory for 4th quarter.
The purpose of the long term cashflow, is not to determine how much profits or money that we will have at the end of 5 years but what are the parameters of our growth. It tells us if we follow that path then we are going to need to borrow or inject more funds at a particular time. If we know that we are going to need more funding in 1 years time, we can start talk to the bank now about setting up a loan facility. We can find out what the bank what to see from our business growth, security etc. We have time to make changes and put things in place.
We do not want to be talking to the bank 2 weeks before we need to make the final inventory payment. That tells the bank that the business is flying by the seat of its pants.
In the show notes, I have a link to a 4 year cashflow spreadsheet that we developed for Amazon based business. Download it and can the assumptions around to see how that affects cashflow.
We will also run an in detail 52 week cashflow model for our eCommerce business, where we will forecast the sales for all our products and when we need to order them. We then look at the cashflow effects to ensure that we have enough cash. If a few weeks are negative cash, we might delay launching a product, slow the sales by reducing PPC. We want to know what is going to happen in 6-12 months. It also makes running the business far less stressful, if we know that if things go according to plan, we wont run out of money.
I usually work out a high and low version as well, If sales take off and if they decrease. That way I can look at the trend months beforehand and adjust what I am going to order.
This kind of modeling is crucial because the decisions you make today often won’t show their full effects for several months. Suppose you adjust your pricing strategy or inventory system today. You might not feel the impact for six months when cash starts running low.
You could forecast these effects?
You’d know in advance when cash might run out and could start conversations with lenders now rather than scrambling for high-interest loans when it’s too late.
Inventory financing and debtor financing, for instance, can carry rates between 20% and 80%. These options are often marketed aggressively to product-based businesses, but they can become a financial trap if your cash needs continue growing due to low contribution margins or high growth rates.
Many businesses think they’ll pay off the financing within a few months but find themselves continually dependent on it, caught in a cycle of high-interest debt.
Closing Thoughts and Closing
Understanding and managing cash flow is essential to running a successful business. Knowing your cash flow dynamics, building a reliable cash flow model, and planning for growth are key. Remember, the decisions you make today will show up in your cash flow in six months or even a year. By planning ahead and understanding your financial model, you’ll be better prepared to make smart decisions that keep your business profitable and sustainable.
The key takeaway today, think about how the cashflow cycle works in your business:
- Is cashflow an issue. What delay do you have between profits and the cash being available.
In a later episode we will go into detail on building a cashflow model
Thank you for tuning in to today’s episode of The 255 Framework.
I look forward to diving deeper with you in the next episode as we continue to explore the buddy of cashflow - which is risk.
If you enjoyed today’s episode, make sure to subscribe to Spotify, Apple Podcast, Youtube so you don’t miss any upcoming episodes. And if you have questions or topics you’d like me to cover, reach out to me via LinkedIn - Arnold Shields. I’d love to hear from you and include your questions in future discussions.
Once again, I’m Arnold Shields, and this is "The 255." Thanks for listening, and I’ll see you next time.
