I am frequently asked why a business can have great profits but are struggling with their cash flow. There is a great reason for this. Profit does not always equate to cash.
Learn How to Read a Profit and Loss Statement.
Firstly, let’s be super clear about the difference between turnover and profit. A business can have a multi-million dollar turnover. Big deal! I want to know what their profit is. It’s the profit which really counts as important. You can have a multi-million dollar turnover and actually be running the business at a loss.
“Turnover is vanity, profit is sanity.”
So, let’s work on the basis that you have a good profit. Let’s say that your profit is $30K last month (you’re a pretty small operator), but when you look at the bank account, you barely have two dollars to rub together. Why???
Profit does not equate to cash.
In this scenario, let’s image:
- Your business bank loan is $2,000 each month as a loan repayment.
- You drew $5,000 in drawings (personal money you didn’t actually take as a wage but took out of the business bank account)
- You purchased a new computer for $2900, and
- Your last 5 invoices (totalling over $20K) have not been paid yet.
The first three above examples are money outgoing. The fourth example is a case of money NOT coming in. All five of these examples do not appear (directly) on the Profit & Loss statement, but rather sit on the balance sheet.
So your profit shows as $30,000, but $20,000 isn’t paid – that brings you down to $10,000. Now take off the loan, drawings and computer. You are now down to $100. No wonder you have no money in the bank. Of course, last month’s debtors might pay or you might have had surplus cash left over from prior months. Or, if you haven’t been diligent with debt collection calls (which should be done at least weekly, if not more often) then maybe next to no one will pay. Just to add fuel to the fire, if you are GST registered, you will likely owe the ATO some money too. After all is said and done, if you did show a profit, then you’ll have to deal with income tax as well.
This is why it’s so important to understand your Balance Sheet, to keep on top of your debt collection and not go crazy on spending just because you issued some great invoices. Imagine (it’s not too hard these days) that one of your major customers does a ‘runner’, files for bankruptcy or just drags out payment until eternity … it can really impact on your cash flow. Turnover might be brilliant, profit even pretty good, but if customers don’t pay, it doesn’t mean a dang thing!
Need help getting clarity around your figures, getting in more business and improving your bottom line by having an effective and efficient business? Call me on 0411 622 666. My business coaching is practical, down to earth and real. I’ve run businesses myself for decades successfully; I know what needs to be done to have a solid and sustainable business.
