Cash-Flow Trumps Profits - here's why
Profits are nice, but Cash Flow will always rule.
Remember the saying; Cash Flow is king!
When it comes to financial accounts, the vast number of small-medium businesses tend to spend much of their pouring over their Profit & Loss statement to see if they made a profit or not.
While making profit is a good thing, some business may prefer not to show a profit – for any number of reasons.
We’ve worked with many businesses who’ve said to us “if I’ve made a profit, how come I don’t have money or where is the money?”
The answer to this is simple; there is a big difference between making money and managing it.
So often business owners start their business because they love creating a new widget, or offering a leading-edge service, but they have little to no business management experience.
Terms like forecasting, budgeting and cash flow are meaningless until the monthly bills come due and payroll can’t be covered.
ASIC continues publish statistics on business insolvencies where one of the key reason was poor Cash Flow management.
If more businesses start understanding the importance of Cash Flow, the more successful they’ll become.
So, what is the difference between Profit and Cash Flow?
Profit is revenue minus expenses.
Simply put, any monies left over after all the bills are paid is considered profit.
Whereas Cash Flow refers to the inflow and outflow of cash in the business, i.e. where is money coming from and where is it going to and why.
Thanks to the accrual method of accounting, profit tends to reflect the current and future state of the business.
If your customer pays you cash for your product, you have that cash now. If they pay on credit, then you still record the sales as a transaction, however, you will not receive the cash until a later date.
Imagine going to a café to buy a coffee – if you have no money, then you have a Cash Flow problem. And if you are promised money in two months’ time, then buying that coffee is impossible until in two months’ time.
Some business owners believe if they just sell more they will have more money. The opposite is true.
Selling more may mean less money in the bank because you may have had to buy more raw materials or hire more people, i.e. expenses have gone up.
The time between selling something and getting paid for it is what Cash Flow management is all about.
What is Cash Flow management?
Cash Flow management is all about timing when cash comes to you and when it leaves you.
There are some simple steps business owners can take to ensure they get this ‘timing’ right.
First and foremost, you must be on top of your accounts receivable
These are monies owed to you for the products/services that you’ve supplied.
It’s common place to provide terms of payment, e.g. within 7 days, 14 days, 30 days etc.
Whatever your terms of payment are, be sure you customers understand this.
If you have terms of payment that are 14 days and after 30 days you still don’t have the money, you are now heading into a collections problem.
The longer you wait to collect you owed money, the harder it will become.
Second, negotiate better accounts payable terms.
These are people who YOU owe money to.
Think about this; if you receive money from your clients within 14 days and you not have to pay your suppliers for 30 days, then that’s a whole 14 days the money sits with you!
Negotiating better accounts payable terms could be as simple as paying a small deposit
upfront with the balance of payment paid in 30 days.
The key here is to work with your suppliers so you both benefit.
Finally, if you can’t meet your financial obligations in a timely manner then you may need to think about raising additional capital from other sources, especially if you need to employee costs and/or buy more inventory.
The more informed you are about your business’ finances, the more likely your business will succeed.
Aperture Accounting can help you stay on top of your finances with tailored and personal advice.
To find out more, call Aperture Accounting on 1300 APERTURE or 1300 273 788.