We’ve all heard the quote “turnover is vanity, profit is sanity, and cash is always king”…
We understand that turnover is the level of sales our business makes, we also understand that some things we sell make more money than others and that it is never a good idea to sell something at less than it costs to provide.
But do we really understand what cash flow is and how to use it to benefit the growth of your business?
In essence, good cash flow is securing the profit you have made on the Companies turnover as soon as possible and paying for the inputs, that were required to make that sale, on time. Inputs could be the simple cost of an item, distribution costs plus administrative overhead. Or they could be more complex, say in a situation where a process is used that has many inputs at every stage in the process.
Paying for the inputs
If you need to pay for the inputs before you receive the actual cash you will need to find a solution to cover the cash costs. Cash is therefore separate from the accounting profit.
If you are producing a product over a number of months (like a house for example) there will be many costs that need to be paid for to end up with a finished house that can be sold. From an accounting perspective these costs will be deducted from the sales price to arrive at a profit when it is sold. But until it is sold cash is going out of the business and is being recorded as ‘work in process’ or ‘stock’ as an asset on the balance sheet. This is just an accounting way of carrying forward costs to allocate them to the sales value in the future accounting period, but this has no resemblance to the cash reality of what is going on.
It probably goes without saying that the best cash flow you can get is to receive the funds up front.
There are many ways to ensure this happens and in businesses that serve the consumer it is the norm.
However, further down the supply chain there are many more businesses that add value to a finished product or service. The norm here is to offer trade credit terms allowing time for a customer to pay for the good or service provided.
The use of credit
The use of credit allows for faster delivery of the good or service as invoicing and payment are not required beforehand. It has sparked many industries – credit control, credit reference agencies, debt collection, trade credit insurance, invoice finance, to name a few.
With the ability of customers to pay late or go out of business before the payment is made to you it is no wonder that this availability of credit is a cause for much consternation. In the UK many businesses are regularly paid late – this is the same for those involved in public and private supply chains.
Late payment is more normal than payment on time. This has an inevitable knock-on effect that means Companies paid late cannot pay their supplier commitments and so on down the line. The first step in good cash flow is rarely adhered to.
Even in industries that supply to end consumer businesses (such as supermarkets and cafes) that take payment from their customer on the day the goods are sold, credit is given to them by their suppliers. This credit allows the retailer to stock their shelves with unpaid products in the hope that these get sold before the payment is due to be made to the supplier. If they don’t, this can have a negative impact on cash flow as they will still be required to pay for them.
With trade credit a necessity for the smooth operation of business, it is those businesses that manage their cash flow well that will have excess cash available to take advantage of new opportunities.
In business there are many phases but cash flow can be split into 3:
- Scraping by, or just surviving
- Extra cash for investing back in
- Excess cash to start taking rewards
Personally, I find statements like these quite misleading as they imply that there is a clear point at which one phase starts and the other ends. But imagine, if you will, lots of grey areas and cross over between them and also that you can move up and/or down the scale depending on how good you are at managing your cash.
Level 1 is when you barely have enough cash to cover your costs of operating – there is no spare cash – most often this is attributed to start ups, but I know of many businesses that struggle to move past this phase as they don’t follow the next step before reaching the third – those businesses are forever doomed to either just get by or die!
Level 2 is where you have extra cash in your business over and above operating costs – my goodness you’ve worked hard to get to this point. You are now thinking that having made some headway it is time to take some money out for yourself.
I’ve been here and I know the temptation is hard to resist. But resist it you must. You are not yet the owner of a business – just a better paying job!
If you want to benefit from the freedom that a business that can operate without you can provide, you must use the extra cash generated by the business to invest it back into the business. Improve your capacity, develop systems that encapsulate your vision so that you can employ people to operate and manage them for you – you will make the business more consistent/reliable for your customers which will in turn make it more valuable to you. A potential purchaser can be shown that the business operates without you – you will be amazed what this adds to the multiples you can achieve at sale…
Level 3 is the point where, as an owner, you can start to reward yourself for having put in the extra effort at level 2. The business has sufficient cash to operate and take advantage of opportunities and any excess cash can be withdrawn to allow you the freedom to live the life you always wanted.
This is not to say that ‘the business runs itself’ and that you will never again experience cash flow crises – the size of a business is no guarantee of plain sailing and consistent profit – just look at Woolworths, Carrillion, Thomas Cook and Intu… they all ran out of cash even though they were ‘profitable’!!
But, with a focus on generating cash first and NOT accounting profit, I believe these steps can be navigated and the ingrained discipline around cash management that will have developed will be a good basis for continued success.
Playfair Finance wants to help as many businesses as we possibly can. Contact us today so that we can help you set up a plan and work out a solution to keep the cash flowing through your business.
Call us today on 01383 624 425 or submit an enquiry and we will contact you.