By Ian Ash
I have often before mentioned the following anonymous quote: “Turnover is vanity. Profit is sanity. Cash is reality.”
And this turns out to be so true.
According to Business Insider, 82 per cent of small businesses fail because of cash-flow issues.
So let’s start with the latter and most important one first – cash-flow.
Understanding your cash-flow is far more than just looking at your bank statement on a regular basis. It is about being able to forecast with a reasonable degree of certainty how much cash you will have in the account over the coming weeks and months, and whether you might need to dip into savings or a loan account in order to keep in the black.
Cash-flow management is all about understanding what monies will come into your business bank account in the future and what funds will be going out.
Note that the incoming amounts are not necessarily easy to predict since just because you have invoiced a customer for products or services, it doesn’t mean that you will definitely receive the funds soon after (for example, manufacturing businesses typically pay 30 days end of month).
Any cash-flow modelling therefore needs to make a conservative prediction about when the money will actually hit your account.
Typical profit and loss statements do not include tax, but when forecasting your cash position, you must include tax payments (such as BAS and IAS) as well as the GST for invoices and receipts. Not forecasting this can lead to some nasty surprises, so always good to put the GST payments by as these are incurred, so that you have the funds available when needing to pay your business activity statement.
Profit is indeed sanity.
If your business is not profitable, you won’t generate the cash to survive and so understanding, and being able to predict, your profit and loss over coming months is
invaluable.
The process starts with determining what you believe your business income and expenses for the forthcoming period are likely to be.
Sometimes I hear business owners say that you can’t possibly predict your sales, but by looking at what happened over previous financial intervals, it is possible to derive reasonable and realistic estimates.
Similarly, expenses don’t tend to vary wildly from year to year so if you have kept a good record of expenses, you can then produce a reasonable approximation for the forthcoming year. When your estimated income and expenses are put into a month-by-month forecast, you can create a budget from which your monthly and annual net profit can be derived.
The third essential key is a balance sheet.
Ask a business owner if they have heard of a balance sheet and most will, but ask them to describe its purpose and what it contains and you are likely to hear the proverbial crickets chirping.
A balance sheet effectively describes a business’ health at a particular point in time.
It is comprised of a list of assets and liabilities and subtracting the latter from the former, gives you what is known as (owners) equity or net assets.
Assets are made up current asset’ (cash and money owed to you) and fixed assets (everything the business owns, e.g. property, plant and equipment, etc).
Liabilities is everything that the business owes, e.g. loans, debts and unpaid bills, etc.
So, if a business sold everything it owned and paid off everything it owed (i.e. assets minus liabilities), what is left over (equity) should give a good an idea of the business’ net worth.
If the equity is negative, then the business is said to be trading insolvently – not good and not legal!
Ian Ash is the managing director of OrgMent Business Solutions.
