Out of Business with Good profits

We have heard many business owners question, “why am I out of business, with good profits”, simply put, Business cash and Business profits are not the same thing and they are not even created equally. Without Cash for the day-to-day running, an excellent profit margin won’t mean squat.

So what’s the difference? Business Cash as we know it is the measure of your businesses ability to pay bills on a regular basis. Profit, however, is the difference between the total amount your business earns and all its costs, usually assessed over a trading period.

 The profit of a business is represented on paper, on the individual accounts. Profits will relate, for example, to credit sales, which are sales earned, when the goods are “sold”, with no payment received.  Profits will also relate to payments made, i.e. purchases, on credit, with no cash. So in essence profit of a business is derived by the difference of total sales, both actual and on paper (credit sales) and total cost, both actual and on paper (credit payments).

The business cash is represented by the actual cash in the bank. However the business owner should be mindful that the cash in the bank, does not necessarily equate to cash in the business. Any sales done on a cash-bases, ensures money is readily available for business use for payments, reducing the amount of cash immediately.

Distinguishing the profit position and the cash position is important in that, even if the business profit is in the positive (due to high credit sales), the cash position may be much less (due to low cash sales), therefore, the business owner is able to make informed decisions to adjust elements of the income statement to reduce the profit, to ensure cash availability, or, take steps to inject more cash to sustain the profits generated.

An example of this feature is evident in overtrading, whereby increased sales, (usually credit sales), incur cost associated with these sales. The business owner may find themselves, unable to pay for the increased costs, associated with the increased business, due to the lack of cash, which is held by the credit sales leading to Bankruptcy.

So although on the books, the business shows that over a period of trading, the profits of the business have been shown to be more than sufficient for the business, the cash position has shut down the business. Keep your business eye on both sets of figures.

Controlling Your Business Cash flow Components

To manage your cash flow, it is important you know where to look.  The cash that flows through your business can only come from and go to specific activities within the business to keep it a going concern. Keeping your personal finances separate from the business is important for this one fact. Mix the two and your business is sure to run into cash flow problems.

There are five main components of cashflow; keeping in mind that cashflow is composed of both inflows and outflows.

The first of the components in your business is Sales/Revenue/Income. This outcome is cash generated from your core business. Because small businesses are highly sensitive to cash fluctuations, control of sales is imperative, due to the fact that process and delivery of sales of the product/service requires a cash input. If a small business grows, in terms of the rate of sales, faster than the resources allow, i.e. cash availability, due to increased costs, termed overtrading, this will have a detrimental effect to the survival of the business, if it is not controlled. This is further exacerbated if sales are provided for through credit.

The Second component of the business cash flow activity consist of available finance, composed of  Bank overdrafts, Factoring facilities and additional funds made available by the Owner, in the form of Loan(s) to the business. It is imperative that a business has access to these facilities of cash to alleviate any cash shortfalls that will be encountered. However the business owner should note that the additional funds have a cost implication which will affect the businesses bottom line. Controlling this activity involves good planning, in the form of Cashflow projections. If this tool is used effectively, the business owner is able to pre-empt the use of these facilities, making early provision in terms of cost reduction and building in the cost of the facility if possible.

The third component of cashflow involves the cash expenditures made by the business, i.e. in paying for overheads, all the consequences of producing the products or services for the business. Salaries are more often the largest and most inflexible cost. Other major costs include stock, raw material and any capital expenditure. The costs involved are either fixed or variable cost. To a large extent fixed cost can not be adjusted in the short term and control should be emphasised on the variable cost of the business, which change in response to the activities of the business. Ensuring variable cost are kept at a minimal, efficient level, will enable the business to divert the use of its cash, from paying expanses to other income generating activities, i.e. investing.

The fourth component involving the use of cash in a business, are payments made towards VAT and Tax. These cash flows are regular and can be of a significant amount, especially if the business does not comply with regulations. There are however significant opportunities a business are can take advantage of, in terms of Tax benefits, which can have positive impact on the businesses cash flow. It is therefore imperative that a business keeps stringent records of its all activities to ensure these benefits are realised.

The final component of the cash flow cycle is composed of payments made to the business owner/shareholder(s) in respect of returns on their investments. In many instances businesses are formulated to provide investors with a return for monies invested, these payments, in the form of interest or loan repayments. Management of the business cash flow enables the business owner to calculate the ROI payment decisions and track the direct impact on cash liquidity.

These components of cash movement in a small business should be monitored daily through the various tool available, be it cash projections, cash gap analysis, payment and expenditure trends, which the owner should become familiar with from the onset.

Please provide feedback on the article above and if you need further information on Cash Management contact:

Cash Management Specialist

E-mail: dumiKm@optikollect.com

Tel: +27 765808 779