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

cash flows like water

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

This is one of the most common questions business owners ask when we first meet. Their business is successful but it doesn't seem to be reflected in their bank balance. Or if the business is doing less well "why am I putting all this effort in for so little money?"

 
It seems a simple question. The answer is less simple because your cash depends on the following:
 
  • how much profit you have made,
  • changes in level of working captial,
  • new investments (fixed assets) made,
  • Increases in financing (loans, overdrafts etc) 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 a stream. It flows into your business as profit from operations. It flows into pools and ponds (working capital), some of these pools are stagnant. It may leak away or evaporate (inefficiencies, bad investments) before finally making into the lake you want it in (your bank account). From there you take what you need (dividends/drawings).
 
So there is a lot to go wrong before the cash reaches you.
 
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 really know everything you are taking out of the business. 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 exactly how much you have extracted.
And that means that owners often underestimate this. So it should be one of the first things to look at.

Financing 

This can be either in the form of loans or as new investment. Both increase cash in the bank. Both come with strings attached. Loans need to be paid off, come with covenants 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 (for ever) etc. Your share and control of the business is diminished. The good news is 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 new premises? This does not immediately affect profit but it does hit your cash. If you paid by cash you will have taken money out of your bank account.
Or 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

In nearly every company I see, there are issues in how working capital is managed. The strength of working capital management can be a good indicator of how well a business is managed. 
The good news is that this is where small changes can have a big impact on both cash and profitability.
The components of working capital you need to manage are:

Receivables (debtors)

You may need to give credit to get a sale. That means money tied up with your customers is not in your bank account. Tips for improving your management of debtors:
1) Don't give more credit unless you need to, and don't give more than you need to.
2) 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 don't get paid.
3) 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. That is not uncommon. The mistake they made was they continued to do work for this customer which eventually went bust which very nearly destroyed the consultancy.  

Payables (creditors)

That is how much you owe to suppliers, staff etc. A few tips:
1) Include credit in your negotiations with suppliers before you buy anything. This is the point they are keen to sell and are most likely to be flexible.
2) Pay when the debt is due not before. Some business owner like to pay early. That is not a great idea - you use up cash and you lose the ability to get better prices that early payment could afford.
3) Keep track of how much you owe and when. If you do not do this you may not have the money to pay on time. 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.
 
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 your finance system). So if a supplier has delivered goods or done some work for you, you have a debt that you will have to pay (this is called an accrual).
  • What you owe to your employees (wages, bonus, pension etc)
  • What you owe the tax office (and 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 things 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. That is by SKU (stock keeping unit). There is no point having 100 HB pencils and no ballpoint pens if people need ballpoint pens.
  • You have to time your buying so you have the stock available when you need it.
  • You need to know how much stock you have on hand and on Purchase Order.
  • And you need to be proactive about managing the stock you on hand and on order. If it looks as though you are going to have too much of any SKU, work out how you can clear it.
You do not want to have all your cash tied up in stock. And badly managed stock can destroy your profits. It hits holding costs (storage), there is more chance of damages, it may become obsolescent (particularly true in food, fashion, electronics), the chance of theft increases, and you may only be able to sell with big discounts or even find you can't sell the stuff.
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 the 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 will take several months, negotiate to be paid in stages - say at the completion of each phase or substantial chunk of work. Ask for a prepayment. If you want to get paid at completion of each stage make sure you agree scope with your customer and get them to sign off the completion of each stage.
Work in progress almost caused a successful and profitable car repair workshop I worked with to go out of business.  They had no money and consequently were unable to pay their 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, the parking area was full of unrepaired cars, so full I couldn't find a space to park. If he'd had a magic wand to remove that backlog 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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