23rd April, 2015
Cash flow is often a problem in small businesses, but it’s even harder to understand if your business is profitable. In fact, many profitable businesses will go out of business because they don’t have enough cash to fund the business.
Profit does not equal cash: it is as simple as that! Profit is made after you have made sales and paid all expenses. Of course, you will have to pay tax on the profit as well. The remaining amount is then reinvested back into the business or distributed the owners.
Cash is what the business needs to operate every day. Cash can come from different sources — profit is one — but you can also generate cash for the business by selling assets, contributing your own personal funds, using bank loans or seeking new investors.
The key to remember is that we don’t spend profit in our business — we spend cash, and it is all in the timing. Firstly as the old saying goes, you have to spend money to make money. To make a profit, you first need to purchase goods or services to sell, so you will need cash before the sale is made. By selling your product or service at a higher price than what it cost, you make a profit. The point is you need the cash before you get the profit.
The second timing problem — the one that catches most businesses — is providing credit to customers. The longer the customer takes to pay, the longer you have to wait for the cash, and in the meantime you have wages, rent, stock and other expenses to pay. This is where the trouble begins and often ends.
You need to focus on not only profit but also what drives your cashflow. If you have regular loan repayments, rent and other expenses that have to be made on time, then you will need enough cash to cover these while you wait for your customers to pay. Keeping track of your accounts receivable and following up on late payments will definitely help your cashflow. The other thing to remember is if you can get credit from your suppliers, this may mean that you don’t have to pay for stock until you have sold it — again making a big difference to your cash flow.
READ: Cash flow statements: Preparation, examples and a template
A business will need to be profitable to stay in business, so we also have to be weary of sacrificing profits to generate cash. Offering discounts to pay early will definitely help your cash position but will reduce your profit. To alleviate the conundrum of cash versus profit, it is best to make sure you have enough cash stashed to cover ongoing expenses. You may consider having a finance facility in place that will tide you over during a cash flow shortage, but this will cost in the form of fees and interest, which will reduce your profit.
Just remember, profit does not equal cash!