Cashflow tip – I make profit but no cash! What is happening?
You are making a profit but have no cash and you are wonder why?
This may be because a company report can show they are making a profit but have no cash because profit is an accounting record using revenues and expenses, (accrual accounting) which are different from the company's cash receipts and cash disbursements (cash accounting). In other words, there is a difference between revenues (invoiced sales) and receipts (actual cash receipt of payment of invoices (banked)). There is also a difference between expenses (purchase orders still to pay) and expenditures (actual payment of purchases, and overhead expenses).
Example 1
A company sells $10,000 to its clients in a month and the clients are given 30 days to pay. The company will have $10,000 of revenues in its first month, but the cash will not be received until the second month. If the company's expenses are $7,000 in the first month, the company will report a profit of $3,000 but will not have received any cash from its clients (it sits in debtors or accounts receivable). It has not been paid the first month, and it may not have paid its expenses either.
Example 2
Another company might report a profit of $60,000 in its first year, but during its first year it uses $65,000 of cash to acquire equipment that will be put into service at the beginning of the second year. This company will have a profit, but will not have the cash, as equipment was purchased, but it is not entered in the expenses on the Profit and Loss to come off the $60,000 profit!
Put another way, cash is paid out, but the profits are not reduced at the time of the payment, because they don’t pay for expenses but pay for assets – they go to the Balance Sheet and include prepayments of some items, payments to increase the inventory of merchandise on hand, and payments to reduce liabilities like super, GST, PAYG.
Profit is the accounting record of what is left after you have made sales and raised all expenses (not when the cash for these events actually happens). Of course, remember there is tax on the profit as well. The remaining amount is then reinvested back into the business or distributed to the owners.
Cash is what the business needs to operate every day and can come from 5 different main sources — profit, selling assets, contributing your own personal funds, bank loans or new investor money.
Cash and Timing
The key to remember is that you don’t spend profit in our business — you spend cash, and it is all in the timing.
There are 2 timing situations to be aware of –
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, or else get credit and pay the supplier later!
Secondly (this catches most businesses) - 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.
Focus on what matters - cashflow
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 if you have to 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.
The business needs to be profitable to stay in business. Be careful of sacrificing profits to generate cash. Offering discounts to pay early will definitely help your cash position but will reduce your profit.
The best management is to make sure you have enough cash buffer to cover ongoing expenses. Having a finance facility (overdraft, credit card) can help that will tide you over during a cash flow shortage, but this will cost in the form of fees and interest, which again, will reduce your profit.
Remember profit does not equal cash!
Need help? Not sure?
Call for FREE 30min advice / strategy session today! Aus +61 407 361 596
and also get FREE “Avoid these GST mistakes” – There’s 18 that the Tax Office see regularly – Get them right!
Call for FREE 30min advice 0407 361 596
or click for the list of our articles.
~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~
