A few weeks ago our article talked about the Myth of Profit and how profit in the accounts does not equal cash in the bank. Since I wrote that, I read somewhere that 95% of all new businesses fail within the first four years because of poor cash flow. If that is anywhere near the truth, then turning profits into cash is the single most important issue facing business owners, especially new and small business owners.
So how do we turn Profit into Cash in the bank?
Firstly, cash in the bank comes from sales. If you are lucky enough to have a cash business then you have a head start in turning profit into cash. For the rest of us, most of our sales are on a credit basis. So that is the first challenge; turning that credit sale into cash in the bank.
Non-cash sales become debtors and those debtors are stopping you turning profits into cash.
1: Controlling how much money you are owed;
So, let’s talk about credit terms. When does the credit sale become due for payment?
I have seen the terms be 30 days from date of invoice, 30 days from the end of the month and a variety of other options. Generally, the best option is 30 days from the date of the invoice. It is the clearest, it leaves no room for doubt and does not extend the allowed credit period beyond the intended 30 days.
If the terms are 30 days from date of invoice then it is important that the invoice is raised and sent to the customer as soon as possible after the sales is completed. We have seen businesses that raise invoices a week, or even a month after the actual sale. But these days, with cloud systems and instant access to your accounting software there is no reason not to raise an invoice immediately a sale occurs.
Many an otherwise good business has sunk in a quagmire of unpaid sales invoices.
It is important to have a good credit control system that relentlessly chases outstanding invoices and ensures that they are paid as soon as they are due. Monitor your debtors regularly.
If, for whatever reason, it is regularly taking longer to get payment and that is killing your cash flow if may be possible to turn sales invoices into cash by transferring an interest in those invoices to a third party. There are several ways to do this but the most common are Invoice Discounting or Invoice Factoring.
2: Plug your Cash Leaks
How often do you purchase stuff that the business doesn’t really need?
We all do it; the discount on the extra paper purchased seemed like a bargain at the time,
The series of advertisements in a particular magazine seemed like it would bring in a lot of business.
When we started our accountancy practice, seven years ago, we got a really good deal on a quantity purchase of business envelopes, A4, A5 and standard window envelopes.
Seven years later we still have a substantial quantity of those envelopes in stock, but with email, scanning and cloud accounting we will probably never use them now. Cash tied up in useless stock.
Do you have cash tied up in stock that doesn’t move, in equipment that isn’t necessary, in advertising or similar expenditure that will never pay for itself?
3: Avoid taking on too much Debt:
In the last article, we showed how loan repayments are not reflected in the profit and loss account. But they suck the cash out of a business. It is often necessary to take out a loan to finance expansion, to purchase new assets or to tide a business over a bad period. But too much debt can strangle a business by taking cash out of the bank.
So, avoid debt when you can and, when you must take out a loan or overdraft, make sure that the repayments can be met without an unnecessary strain on the business.
4: Have a Cash Flow Budget:
A cash flow budget will let you see how the money is coming into the business and where it is going. A properly prepared budget will show you the timescales of the cash inflow and outflow of the business. It will highlight if the business is taking on obligations that it cannot afford. It will keep you on track and help instil financial discipline into your business.
Ideally a budget should be prepared at the beginning of the financial year and should regularly be compared against the actual performance of the business, so that any necessary action can be taken to avert cash flow difficulties.
5: Finally Watch your Drawings:
In most businesses cash is like a roller coaster. The business will have periods where it has cash in the bank and periods when cash is short. When there is ample cash the temptation is always there to increase the owner’s level of drawings. The danger then becomes that the owner gets used to a level of spending which cannot be sustained. I know of a 3-man partnership which was involved in the construction industry. Their business had been going well and prospering for some time and they had gotten used to enjoying the fruit of their success. But when the recession of 2008 came along and the construction industry contracted dramatically the partners continued to enjoy the same level of drawings as before. A short while later the business folded.
6: Cash is King
The main cause of small business failure is cash flow problems. Turning profit into cash is a major challenge for business owners. Effective cash management is the key to a successful business and growth in the long term.
Do you need help in creating a cash flow budget or setting up an effective credit control system feel free to contact us; firstname.lastname@example.org or call 02891072561. Initial consultations are always free of charge.