I heard the old Banker’s adage “Turnover is Vanity; Profit is Sanity and Cash is Reality” again this week and it has stuck in mind.
It is a simple but profound statement that reminds us where our focus should be in business.
No doubt you know of business people whose focus is on turnover. This gives them a sense of achievement. But what is increased turnover if it does not give you increased cash flow?
You cannot do anything with increased turnover alone, but you can with more cash.
Generating cash flow is what matters.
What is cash flow?
It is the increase in cashless the increase in debt over a period of time, be it a month or a year. The bank account may be higher, but if debt such as credit cards have increased then that is not positive cash flow, but negative cash flow.
A cash drain.
Without cash flow, there is stress on you as the business owner impacting your effectiveness in the business and outside the business.
It can mean difficulties getting supply and being able to grow the business.
Lack of cash flow puts the business into survival mode.
When there is a cash flow problem the instinctive response is to increase sales or cut overheads.
This may be totally the wrong answer.
Many businesses chew up more cash in stock and debtors if they increase sales.
For them increased sales is not the answer.
When you take on more work does cash flow grow or shrink?
The simple way to look at this is to compare the gross profit generated by an extra dollar of sales with the working capital that extra dollar will chew up.
The working capital that an extra dollar of sales uses is; your debtors, plus stock, fewer creditors, as a percentage of annual sales.
For example, if debtors plus stock fewer creditors equal $350,000 and annual sales is $1 mill, your working capital percentage is 35%. Each extra dollar of sales will require 35 cents of working capital. If your Gross Profit margin is 25% then for every extra dollar of sales your cash flow will drain by 10 cents.
Growth is bad for cash for a business like this.
Before you can grow this business you need to either:
- Decrease the number of days your customers pay you.
- Decrease the amount of stock you need to hold to do business.
- Decrease the price you buy your goods or materials for.
- Increase your prices, OR
- Get better creditor terms.
Some of these you may not be able to change, but for those which you can change, work out a strategy of how to improve, implement and monitor them. It is also worth seeing what a big difference to the cash flow a small change in the above factors will make.
Once you have gross profit percentage higher than the working capital percentage then additional sales will add to your cash flow. Get your cost structures and working capital right, then adding sales by organic growth or acquisition can increase both profit and cash flow.
Where is your focus?
Taking the time to focus on the internals first will enable you to squeeze the maximum profit and cash out of new sales that you work so hard to get.
Peter Ambrosiussen is the Senior partner of Ambrosiussen Accountants & Advisors www.ambrosiussen.com.au
View LinkedIn profile – http://www.linkedin.com/pub/peter-ambrosiussen/29/171/a24
Published by Toowoomba Chronicle www.thechronicle.com.au on Saturday 1 November 2014