Cash flow keeps a business alive. A lack of cash flow will close a business. It’s important to know how much cash your business needs, and when, so you can plan ahead and have that cash available.
To start, project your overhead expenses monthly. Not every month is the same. Some months you have taxes due; other months it’s an insurance payment. Start a spreadsheet listing your overhead expenses by month, for a full year, as accurately as you can. If you have company history you can use, that’s great, it will be the most accurate record of your cash needs for every month.
If your business is busier some months than others, you’ll want to separate fixed from variable overhead expenses. Fixed expenses are the same regardless of how much revenue your business brings in. Typical fixed overhead expenses are any business rent or mortgage, your salary and the salary of any office staff, vehicle payments, phones, insurances, etc.
Variable overhead expenses are things like fuel, sales commissions, job supervision, advertising, etc. You’ll want to project higher overhead expenses during your busier months to account for those overhead expenses that increase when the sales volume is higher.
Now you know how much cash you’ll need to cover your overhead expenses each month of the year, and when you total it, your projected total overhead expenses for a year. That’s how much cash you need on hand at the beginning of each month to keep your overhead bills paid. Divide your total projected overhead for the year into your annual projected sales to get your ratio of overhead to sales.
For example, if your projected overhead for the year is $150,000 and your annual projected revenue is $525,000, your overhead is 28.6 percent of revenue (150,000/525,000). Now divide each month’s overhead by that percent to determine the revenue needed to pay that month’s overhead. If April’s overhead is $13,500, you need at least $47,202 in revenue in the month of April (13,500/.286).
Once you know your required sales by month, work backwards to determine how much advertising you need, and when, to generate the leads necessary for the sales that will pay those bills. We talk about that in this article, “Calculate Your Cost Per Lead”.
Of course, overhead isn’t the only expense you have. You also need to pay all job expenses on a timely basis, and that means using a payment schedule on your jobs that keeps payments ahead of, or even with, job costs. You can read more about payment schedules in our book, Markup and Profit; A Contractor’s Guide.
And all of this assumes you’re pricing your jobs properly and selling them at the appropriate price. The minimum price for every job is what is needed to cover all projected job costs, your overhead expenses and a minimum 8% net profit, we talk about that in the article “A Minimum Price”.
Did I say it was easy? It takes time and research (and a little math), but the results will let you know if and when sales (and revenue) is needed to keep your business in a positive cash flow position. That keeps your business alive.
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses and their lives. He is the author of the books Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations.
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