Recently we discovered that one of our larger customers was not as profitable as we thought. They were making our gross revenue number look good, but were adding very little to our gross profit. In other words, we were churning cash.
In conversations with small business owners, we have discovered that many small businesses fall into the same trap. They take on customers that buy a lot, frequently pay quickly, but add very little to the profitability of the company. These customers are initially attractive because of the cash flow they create. Unfortunately, in many cases for every $1 that is brought in, $0.99 goes right back out. Thus the phrase: churning cash.
There are times in a company’s life when churning cash is a good thing. In an established company, during an economic downturn a business owner may be faced with the choices of laying off staff or taking on jobs that churn cash. Similarly, if your business has a slow time of year, taking on jobs that churn cash will keep your staff busy and morale up.
However, in both of these situations, it’s important to know when it’s time to stop churning cash. Here is the problem, churning cash is seductive. It lures you into believing you are productive. And hey, cash is flowing, so business must be doing well. Unfortunately, at the end of the day, you have done a great deal of work, possibly used up equipment capacity, and kept very little of that cash.
In the end, we went back to our customer and negotiated a slightly higher price for the product we were providing. Over time, this customer decided to move their business elsewhere. And that is ok. While our revenues are down slightly, our gross profit is up by a very large percentage.
Do you have any customers that are churning cash? What can you do today to stop the madness?