Of the many challenges that small business owners face, maintaining a sound cash flow would be the hardest. As a business owner, do you wonder how it is that you operate a profitable business (and your financial statements show this too) but seem to struggle with cash flow?
In accounting terms, operating profit is the money left once all operating expenses are paid. Some business owners may think that this is the cash balance that should sit in the bank account and is therefore available for use. This is not true. Taxes will need to be paid out of your business profit.
Solution: Set up a separate bank account solely for your tax payment obligations. There is often a timing lag between when a sale is rendered and when tax payment is required, so to avoid overspending, put some money aside for future tax payments.
2. Slow debtor collection
Revenue is recognised once the work is rendered or a product is sold. However, businesses do not always collect the cash from sales immediately. Customers can take weeks or months to make payments and unfortunately, there are a few that just do not pay at all. In the meantime, to keep your business operations going, you will still have to cover all your fixed costs.
Solution: Follow up your debtors and ensure that they abide to your payment terms. If need be, come to a payment arrangement with them. Where possible, issue stock on COD terms. If you are doing project based work, progress billing is key. Before commencing any project work, take a deposit and agree on a progress payment schedule. You do not want to act as financier to your debtors. You’d rather them to be your interest-free financier!
3. Timing lag
Do you run a business where sales are seasonal? Take a plant nursery business for instance. Business slows from late Autumn and is relatively quiet in the winter months with most sales activity taking place only in the Spring/Summer months. As a business owner, you may be ordering stock from overseas and paying for materials in late Winter in anticipation of turning over the stock in the next month or so. In this case, you are effectively outlaying cash before the revenue is collected. This effectively means your profit is tied up in stock until it turns into a sale and cash is collected, which could be another 30-60 days away!
Solution: You need a cash flow forecast. Mapping out when your expected cash inflow and outflow at least every 3 months will help your better understand the fluctuations in cash movements. This can lead to better business decisions such as when stock ordering (and how much) should happen or when asset purchases should take place.
It is important to understand that healthy profit does not necessarily always translate to strong cash flow and a profitable business can still go under due to cash flow issues. Sound management of the timing of your cash inflow and outflow is crucial to keep you afloat.
If your business is experiencing cash flow problems or you simply want your cash flow to improve, contact your Accru advisors who can assist. We specialise in advising on all aspects of business management.
By Chee Hii, Accru Melbourne