High profits does not always equal strong cash flows.
There’s nothing more frustrating as a business owner than having your accountant tell you that you’re making strong profits, however still struggling day-to-day to pay bills when they become due. A common misconception in business is that a strong profit means a healthy business but high profits does not always equal strong cash flows. In this blog we will explore the top three reasons that your cash flow may struggle, even when you’re producing strong bottom lines.
Working capital is the cash a business uses for its day-to-day trading activities. There are three main components that can be addressed when you’re looking to improve your working capital, and in turn your cash flow; these are trade debtors, trade creditors and inventory.
Trade debtors and inventory should be kept low, to ensure that cash is not held up in these two items. The best ways to keep to keep debtors low include continually following up on debtors and troubleshooting any issues they are having in making payment for invoices. For inventory, you should look to not over order stock, however still ensure that you have enough available to complete your day-to-day activities.
On the other hand, you should also look to take advantage of the full credit terms your creditors are offering to you. Delaying payment to the end of your credit terms will also free up cash flow which can be used in other areas in the business. However, it is also important to maintain a strong relationship with your creditors, so running regular reports to ensure you haven’t exceeded any credit terms is also recommended.
We’ve all heard the famous cliché “the only two guarantees in life are death and taxes”. Tax payments should never catch a business owner by surprise. Tax payments are not included in the profit figure of the business, and need to be paid after profit is calculated. The impact of future tax instalments also needs to be well understood. We recommend using a rolling forecast of future obligations to better budget for these payments. Some business owners also operate a separate bank account solely to put money away for tax. Both GST and income tax are significant impositions for business and managing this exposure is critical for cash flow.
Finally, it is important to keep in mind all loan repayments you need to make, including car, property and credit card repayments. Another ‘loan’ that is often neglected is repaying the owner, or owner drawings. All of these items sit outside the profit figure of the business and consume a lot of a business’ cash flow. Therefore, when thinking about your next big purchase, don’t forget about the current debt that the business needs to service.
Our Business Advisory Specialists are here to help! If you are experiencing cash flow issues in your business, or would like to explore any of these items further, please contact us today on 03 9835 8200 or alternatively complete your details below and we’ll be in touch.