As an accountant, I get asked this all the time. I tell clients how much profit they have made and they then ask – ‘Well, WHERE IS IT?!?’
Yes, a lot of profit is taken by owner drawings and taxes, but profit also goes to loan repayments, gets sucked up by increases in stock on hand (needed for resale) and also gets tied up with debtors. Debtors are the customers that don’t necessarily pay you on 20th of the month, but YOU need to pay YOUR suppliers/creditors, so consequently your bank balance goes down!
So a business can be profitable but not have good cashflow. This is generally when a business is under-capitalised, meaning you started the business with next to nothing and relied on profits to pay for your setup and it’s been a continual battle ever since. Two simple ways to improve your profitability are to 1. increase your prices, 2. reduce your expenses or (ideally) both!
Here are some additional ideas to improve your cashflow:
1. Get stricter with your credit policy. Customers could pay on delivery or within 7 days, not the 20th of the month following
2. Decrease stockholding. Just order in what you need. This has the added bonus of avoiding obsolete stock.
3. Sell off unnecessary assets or lease them instead.
4. Reduce personal drawings.
5. Possibly restructure loans by re-negotiating interest rates and repayment terms.
Good cashflow is crucial to maintaining a healthy business. It is advisable to have a good working relationship with your bank manager and to keep communicating with them. They will expect to see regular financial statements, so get savvy with your accounting software system or, if it’s not your strength, get outside assistance with a bookkeeper and an accountant.
It is imperative that you invoice regularly as this is the basis of your cash coming in. Don’t hold your invoices until the end of the month – get them out as soon as feasible once the work is completed. If you have long-term projects on the go, consider partial invoicing along the way instead of waiting to send that large invoice at the end of the engagement.
Ideally you will also have a budget so that you are able to anticipate seasonal fluctuations before they happen. For example: Sales are likely to decline over Xmas as your business is shut down; however, income tax and GST are both due 15 January, so you need to set aside funds for this! Or, perhaps your business gears up all year for your big summer season where you’ll make the majority of your turnover, so you need to make sure you can fund the overheads during the winter period leading up to this.
Budgets (if constructed thoughtfully) also gauge how your business is tracking and can be used as a measuring stick for growth – for example, if you take on a new staff member, how much more does your turnover need to increase by to break even?
There is very little utility in looking back one time each year on the ‘year that was’, so ensure you’re working with a bookkeeper and an accountant who are able to support you to look FORWARD and PLAN. I’ll leave you with this thought: ‘Revenue is vanity. Profit is sanity. Cash is reality.’
You can learn more about how Raelene helps her clients here: https://www.reesaccounting.co.nz/