“Why isn’t there more cash in my bank account?”

cash flows like water

cash and water both flow. You need to control it.

That is one of the questions business owners often ask me when we first meet. They feel there should be more cash based on the success of their business. Or if the business is doing less well "why am I putting all this effort in for so little money?"

 
It is a simple question. The answer is less simple because your cash depends on the following:
  • how much profit you made,
  • changes is level of working captial,
  • new investments made,
  • Increases in financing and
  • dividends or drawings you've taken out.
For those who like equations:
Cash = P - ∆WC - I +∆F - D
 
For those who are more visual: It may help to think of cash as water. It flows in to the business as profit. It collects in pools (working capital, assets), some of which are stagnant. It leaks away or evaporates out of the system (inefficiencies, bad investments) before finally making into the tank you want it in (your bank account). From there you turn the tap to take what you need (dividends/drawings).
Either way how much cash you have or don't have is not necessarily a simple answer.
 
Looking at these factors one by one and in reverse order:

Dividends/Drawings 

We all know how much money we've taken out don't we? Surprisingly the answer is generally "no". And when you do find out it can be a shock.
It is difficult to have visibility of what you are taking out of the business. The problem is the information is hidden in lots of places. Dividends are not shown on the Income Statement. Salaries and benefits (health care, car ...) are often mixed with those of staff etc.... It is very rare for a business to have a report showing how much you have extracted. So that is one of the first things to look at when trying to understand why there isn't more cash.

Financing 

This can be either in the form of loans or as new investment. Both increase cash in bank. Neither is free. Loans need to be paid off and you have to pay interest. Investments put other pressures on your business - different owners may have different priorities, new investors get a share of all future profits etc. Your need for external financing will be lower if you follow the advice in this blog.

Investments and fixed assets

Have you bought a new car or computer (system) or moved to a new premises? This does not immediately affect profit but it does hit your cash balance. If you paid by cash you will have taken money out of your bank account.
You may have taken out a loan to pay for it. That's often the best way to do things and it reduces or even eliminates the impact on your cash in bank. But it increases your financial obligations going forwards.
 

Change in working capital

This is often where there is the biggest opportunity. The strength of working capital management is often a good indicator of how well a business is managed. I have not seen many companies that do this well. The components of working capital you need to manage are:

Receivables (debtors)

To get the sale you may need to give credit. That means cash sitting on your debtors ledger instead of in your bank account. So the first point is: don't give more credit than you need to. The second point is: if you do give credit, make sure your customers pay when the debt is due. Late payment uses up even more cash and increases the chance you will have to write the debt down or off. If a customer is struggling to pay, work with them to create a payment plan.
I recently did some work for a highly rated consultancy. It was growing and profitable. A major customer had been allowed to build up a substantial debt. To make things worse the consultancy continued to do work for that customer leading to an ever increasing debt. That was cash they didn't have to invest in their business. 

Payables (creditors)

That is how much you owe. Negotiate reasonable terms with your suppliers. Pay when the debt is due not before. Many business owners make it a point of principle to pay early. Unless you are sitting on more cash than you need, don't be one of them. If you fail to take and use credit offered, you will have less cash in your bank to run your business. 
Having creditors means you have debts. Debts need to be paid when they become due. Knowing what is due and when is critical to your survival as a business. Stories of businesses driven into receivership by an unexpected tax bill are all too common. Make sure you have a list of everything you owe and when you need to pay. Make sure you have enough money in your bank account to cover your debts.
When you look at your debts include:
  • stuff you owe but don't have the invoice for (or you have the invoice but you haven't entered it into the finance system). So for example if a supplier has delivered goods or done some work for you, you have a debt.
  • What you owe to your employees (wages, bonus, pension etc)
  • What you owe the tax office (this should never be a surprise).. Make sure you know what you owe and put aside the cash to cover these liabilities.

Inventory (stock)

This is one of the most difficult part to get right because you have to be good at so many different things:
  • You have to be able to forecast future demand at the right level of detail.
  • You have to be good at buying so you have the stock available when you need it.
  • You need to know how much stock you have.
  • And you need to be proactive about managing the stock you on hand and on order. 
Too much stock consumes cash and eats away at your profits through higher holding costs, damages, obsolescence, shrinkage, write downs and write offs).
Too little and you miss sales opportunities losing potential profits and leaving your customers unsatisfied.
More often than not businesses end up with too much of what they don't need and not enough of what they do.
Manage your stock right and you can transform your cash position and your profitability.
One customer bought goods from overseas for web based retail in UK and EU. The business was successful, growing fast with a strong reputation. In working together it was clear there was tight control on buying so much so that goods were often out of stock. That hurt in three ways - customers weren't able to buy goods that weren't in stock so they lost profit, customers service ratings went down and  their rankings on e-commerce sites were hurt hitting sales when they got the product back in stock. They calculated that the first factor alone meant sales were 30% below what they could be. 

Work in progress (unbilled work)

The longer the time between doing the work and billing for it the less cash you have. And unfortunately the greater the chance your customer will dispute your bill. So invoice often and on time. If you are working on a project which takes several months negotiate to be paid in stages - say at the completion of each phase or substantial bit of work. Look at getting prepayments. Agree scope and get your customer to sign off at the end of each stage.
A successful car repair workshop had one major issue which threatened to drive them out of business. They had no money and consequently were  unable to pay suppliers on time. The owner was always "out" to avoid having to speak to creditors (think what impression that would create on potential customers). The business was hamstrung.
At the same time it was impossible not to notice the parking area was full to the extent I couldn't find anywhere to park. Nearly all those cars were customer cars waiting to be repaired. If he'd had a magic wand to remove that back log he could have solved his cash flow issues at a stroke. This is an extreme example but many businesses have money tied up in work they haven't completed or billed for.
Profit is not the same as cash. As a business owner you need to actively manage both to be successful. A couple of examples to illustrate the difference:
1)  You buy £100 of goods on 60 days credit and sell them the next day for £80 cash. Your cash position is great - you have £80 in your bank. Profit less so - you've lost £20 on the sale. That type of business is not sustainable. You won't have the cash you need to pay the supplier when the 60 days are up let alone any of your other business costs. This is not as extreme as it may seem. Many business owners don't actually know whether they are making a profit or loss on their sales once they take all relevant costs into account.
2) You buy those same goods for cash and sell them a month later for £120, so you have made a profit of £20 on the sale. But you have to find £100 to cover the fact that it takes you a month to sell that stock. This could be a good business but unless you can find that £100 to pay the supplier the business will fail. 
So avoid using your bank balance as the only measure of how well your business is doing.
The level of profit your business makes is itself is the result of many decisions:
  • The market you are in
  • What you sell and who you sell to
  • how you set your pricing
  • how much discount you give,
  • what are the costs involved in making and fulfilling that sale
  • how well you buy
  • how well you manage your fixed costs
  • how well aligned different parts of the business are
  • how efficient you and your business are
  • how quick you are to spot and address opportunities and threats, etc
 How well you make those decisions depends a lot on the information you have available to you and the quality of your financial management. It is not something you can afford to leave to chance.

Summary

So there you are. To have the cash you want you need to:
  1. have a viable business model,
  2. have the controls, reporting and management capability to ensure you are making the profit you should be making,
  3. actively manage your working capital,
  4. be careful about investments (and expenditure),
  5. get funding if needed,
  6. be aware of how much money you need to take out of the business and ensure your business can afford it.
The cumulative impact of getting these right can transform your business.
 
Contact me if you'd like to find out more about how you can improve profit, cash and make your work place a better place to work. Or if you've any questions about the content of this blog.

About Jonathan Nicholls

Passionate about improving business performance
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