3 minutes read
By Sue Hirst – Director, CFO On-Call

Do you wonder why you have a profit in your business, but not enough cash?

It often boils down to a lack of understanding of the difference between profit and cash flow. Let me explain.

Firstly, let’s start with profit.

The best way to ensure you make a profit is to avoid losses! The best way to avoid losses is to understand your break-even sales point. This is the amount of sales you need to make to arrive at $0 profit (i.e. neither a profit or a loss).

In order to work out your breakeven sales, you need to understand the ‘true cost’ of your product or service. This means the cost of the item and getting it into store and ready for sale, or materials and labour, if it’s a service or job.

Once you know your ‘true cost’, this gives you a better basis for working out the price to charge, to ensure you make a gross profit.

Next you need to consider your running expenses, such as rent, wages etc. These are the expenses you need to pay every month (whether you sell anything or not). Once you know this, you can work out, based on the gross profit for each item/job you sell, how much you need to make in sales to cover your running expenses. You can then use that to work out a target for profitability.

All of the above can be documented in a Budget to help you stay on track. Your budget can be entered into your accounts system and you can report on a comparison between budget and actual results each month. This helps you to stay on track to profit and fix things quickly if they get ‘off track’.

Secondly, let’s cover cash flow.

Once you’ve created a profit by selling something and paying out less in costs and running expenses than the sales amount…

If you offer terms for your customers to pay (e.g. 30 days), you need to have a process in place to ensure they pay as quickly as possible. Remember this is your money in their bank account and the longer they take to pay, you are acting as a bank to them!

Similarly, if you receive terms to pay your suppliers (e.g. 30 days), you need to have a process in place to ensure you use the maximum days to pay them. I’m not suggesting you don’t pay them for as long as possible, just that you don’t pay early, as this can have a ruinous effect on your cash flow. The longer terms you can negotiate, the better your cash flow will be.

If you are running jobs, it makes sense to get them finished ASAP, so you can invoice immediately and recover your outlays in paying for materials and labour to get the jobs done. Every day you delay invoicing is like dollar bills piled up on your workroom floor!

If you’re selling products, you need to minimise the number of days stock sits in store waiting to be sold. Again, think of stock as dollar bills piled upon the store room floor! There are good systems to help you manage the optimum time for stock holding.

Next you need to ensure you’ve got enough cash to cover taxes and loan repayments. These aren’t included in your Profit and Loss Report, but they have a big impact on cash flow. If you don’t pay on time you will fall foul of the tax office and your lender.

It may be necessary, at times, to inject some of your own funds into your business. It makes sense to do this in an organised way and to ensure that you get repaid ASAP.

A great tool to help you manage cash flow is a ‘Cash Flow Forecast’. It can be a simple spreadsheet, where you document all cash into and out of your business, the balance on any given day, week or month and where the peaks and troughs are likely to occur. Once you know when they are, you can manage them proactively and sleep better at night!

If you would like to learn more about this subject, plus other useful business financial management tips, check out ‘Business Financial Toolkit