Business Finance: If revenue is vanity and profit is sanity, cash is still king, says Carl Page
Many business owners are driven by a desire to increase turnover but lose sight of profitability and, more importantly, cash flow. Sometimes can result in the ultimate failure of a business even when, on the face of things, it is very busy.
Don’t get me wrong; increasing turnover should be a main objective for any business but it should be part of a sound business strategy which also plans for increased profitability and managed cash flow. Lack of cash flow is often the main reason a business fails and it is important to understand how cash can run out even in businesses that are continuing to show growth.
Customer debts: As turnover increases so the volume of customer debt is likely to increase. The effect of this is heightened when customers exceed their credit terms or do not pay at all. The risk further increases where there are one or two large customers and the value of their debt becomes a large proportion of the overall sum.
Stock: In times of growth it is easy to lose control over stock levels, or to purchase large bulk quantities to take advantage of discounts. However, this stock will need to be paid for, often some time before the business receives the proceeds from a sale.
Staffing levels: In particular where large contracts are won, there can be a requirement to increase staff levels. These wages will need paying during the term of the contract, often resulting in the business having to fund the period before receipt of monies from the customer.
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Overheads: Without sufficient controls, it is easy to allow overhead expenses to grow, in turn putting pressure on cash flow.
So what measures can be put in place to mitigate the risk? As mentioned above, the business should be working towards a measured business plan. Customer debts should be collected within strict credit terms and for larger contracts an agreement should be in place for deposits or staged payments. Stock levels should be controlled so as to reduce the length of time cash is tied up and general expenses regularly reviewed.
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Accurate and timely financial information is required which allows you to identify when action is required and, if assistance is required, to seek professional advice at the earliest opportunity. Most importantly always consider the effect on cash flow when dealing in transactions and remember that a sale is not a true sale until the cash is in the bank.
: : Carl Page is a partner at Ensors Chartered Accountants.
This information is given by way of general guidance only, and no action should be taken solely on the basis of the information contained herein. No liability is accepted by the firm for any actions taken without seeking appropriate professional advice.