Cash is king
Cash is king: How to turn more of your profit into cash (part 1 of 2).
If you run a small business, you may look at your annual or monthly/quarterly management accounts and see a nice healthy profit figure. However when you look at your bank account, you might wonder where on earth all that expected profit has gone. Where is all the cash?
The answer to this question lies in how your profit is represented - is it cash or is it simply profits on paper?
In this first part of a two-part blog, I look at the difference between profits and cash and how different businesses operate. In the second blog, I look at strategies you can put in place to make your small business more cash generative and to get more cash in your back pocket.
The difference between cash and profit
Simply put - timing is everything. The way I break it down for my clients is to see your business as doing four things, and the order and timing of those things is key to understanding how you generate cash or not. The four things are:
1) Spend cash: To make the products, goods or to provide the service to the customer.
2) Make a loss: When you receive an invoice or bill from a supplier this hits the books as a cost to the business, making a loss.
3) Make profit: When you raise an invoice this should more than cover the costs of making the good or providing the service, with the net effect being profit.
4) Receive cash: Get paid by the customer for the goods or services.
A typical “cash poor” example
A sole trader who is fitting a new tap for their customer
● Spend cash: Buy the parts and materials
● Make a loss: Pay for the goods and spend your “time” completing the job
● Make profit: Raise an invoice for the job once complete to more than cover the cost of the parts and your time - with the net effect being profit
● Receive cash: In 30 days time expect payment for your work
Do you see how in this example the plumber will not be running a cash generative business as the ‘receive the cash’ part happens a long time after the ‘spending cash’ and ‘making a loss’ part.
A typical “cash rich” example
Larger business (such as the multinational supermarkets) are very good at generating cash and this can be explained by looking at how they approach the four steps above.
A supermarket providing a pint of milk
● Dairy invoices the supermarket for providing the pint of milk and a “just in time” delivery system will get the milk on the shelves almost immediately
● Supermarket has the milk but not yet paid for it - it has not ‘spent cash’ at any point in the process
● Customer buys the milk, paying cash - supermarket makes a profit and receives cash at the same time
● Supermarket eventually pays the dairy invoice - but this could be months later
In this example the supermarket is running a cash generative business as the cash is received a long time before the cash is spent on the pint of milk.
This is why having a very efficient supply chain where goods are not held in stock for too long is important for supermarkets. It also looks very different to the plumbers situation.
Your ability to be cash generative depends partly on your industry
If you are a service based company, it can be harder to understand the difference between cash and profit, but remember you will have normally provided the service first, paying for all the staff and other costs (losing cash) before raising an invoice (getting the profit) and waiting 30 days to be paid (finally receiving the cash).
On the other hand, some service based companies are very cash generative, take for example insurance which normally take the premiums up front and get paid first before providing the service (if they do). They are in the envious position of getting cash first and profit later.
However, it is wrong to think that you should be forced into a cash generative or cash poor position just because of the industry you are in. No matter what industry you trade in, there are some simple steps that you can take to try and adjust the timing of the four crucial points above. My next blog will address this issue.