Where has your profit gone?

Do you often wonder where your profit has gone?  You're pretty sure you're making money but there's nothing in the bank?

And that lack of cash means that your time and attention is taken with juggling the cashflow - sometimes robbing Peter to pay Paul.

Well, firstly keep in mind that profit and cashflow are two very different things. 

You can have a positive cashflow for a while even if you're not profitable - you might just be very good at getting money in from customers and not paying suppliers.  Or you might have just received a loan to help you keep going.  But if you're not profitable, sooner or later your true cashflow position will catch up with you - and then you'll have a problem!

And on the flip side of the coin, you can have a negative cashflow when you're making a healthy profit.  You might not be great at getting money in from customers or your payment terms with supplier might be too generous.

So if you're wondering where your cash has gone, think about looking at your business the same way my grandmother looked at her household finances.  Each week when my grandad gave her the housekeeping, she immediately split it between 4 or 5 jars - there was a jar for paying for food, one for paying the rent, one for paying bills - you get the picture.

And in your business you will probably have between four and eight jars where your cash needs to go:

  • Jar 1 - your bank account

You need to have enough money in your bank to fund the short time financial commitments of your business - to pay your creditors, your staff and most importantly yourself.

  • Jar 2 - your stock

If you have stock in your business you need to manage this carefully.

Too much stock and you'll have items sitting on a shelf gathering dust - doing nothing productive for the business.  And worse still, you may end up with stock which is redundant and worthless.

Too little stock, and you risk missing out on sales.

But if you can get your inventory turning over sooner - lowering stock levels, improving product mix, increasing sales - you can move your cash from the stock jar to the bank jar more quickly.

  • Jar 3 - your fixed assets

Did you pay cash for a piece of equipment, furniture or vehicle? Did you remodel or improve your facilities?

If so, part of your available cash was invested in business assets and infrastructure - a good decision if the result is better productivity or customer service. 

However remember, because assets are depreciated (expensed over time), the profit on your P&L statement won't reflect the entire cost of the purchase right away. However, you will feel the effect on your cash flow immediately.

  • Jar 4 - your accounts receivable (or trade debtors)

The more you sell on credit terms, and the longer you give customers to pay, the less cash you have in the bank.

In fact, you become a bank for your customers - providing them with an interest-free loan - and putting money in their jars when it should have been in yours!

  • Jar 5 - your gross profit

If your gross margin is too low then you're effectively giving your customers a better deal than you can afford to.  And don't be tempted to make it up with volume - that way lies disaster!

So some of your cash is being left in your customer's jar.

You either need to reduce your direct costs or up your price.  And make sure the money ends up in your jar!

  • Jar 6 - waste

This jar contains all the unnecessary money you spend in the business - whether it's correcting mistakes or spending too much on overheads.

This jar can get really full when your sales decrease and you don't (or can't) cut your cloth accordingly.

  • Jar 7 - your drawings

This is the jar that we regularly see being way too full!  And it's the money that you, the owner, take from the business.

It often happens that, because there's money in the bank, the business owner thinks it belongs to them.  And they forget all the other things they have to pay for - including VAT, business tax and their personal tax!

So when those liabilities come due, there's no money to pay them.  And that's when businesses can really hit problems - especially as HMRC can be quite aggressive about getting their money (though not if you're a multi-national hi-tech company it would seem!).

So knowing what's got to be paid out of the business bank account is critical.  Keeping an eye on your supplier liabilities is one thing but you also need to be aware of cash payments which won't necessarily be paid out for a while - such as your tax.

We recommend clients have a separate bank account and use this to put 'untouchable' money in ready for when those 'hidden' or longer term liabilities become due.

You don't want to be responsible for the demise of your own business!

  • Jar 8 - your rewards

This is the best jar of all and one that fills up quickly when you have a great business.

It's the profit after tax that your business is making and which you can then take out for yourself - whether you're a limited company (as dividends and/or salary) or a sole trader/partnership (as drawings).​

And remember, for a stress-free life you don't want to be tipping money in and out of all these jars!  You want your money flowing smoothly in a logical order with most money ending up in jar 8!

If you'd like someone to help you take care of your 'jars', feel free to give us a call on 01202 048696.  We're here to help!

Spread the word!