Why doesn’t Cash follow Turnover?

I was talking to a business owner recently who was telling me how he had recently increased his marketing and as a result his  turnover had increased dramatically. As a result he was extremely busy. When I asked him if he had any plans to bring some new staff into the business in order that he could cope better, his response was that he couldn’t afford  do that. It turns out that although turnover was up, that didn’t translate into more cash in the bank; in fact quite the reverse. When I asked him why did he think that was, he replied, “You know, I’m not really sure….”

It turns out that in order to increase turnover he had reduced prices, so gross profit was lower. And the marketing methods he had chosen were quite expensive. And of course, the higher demand meant he had to buy more stock, so more cash was going out. And because he was so busy servicing customers he wasn’t planning his stock purchases so carefully so had dead stock on the shelf, and he wasn’t chasing the debt so regularly, so incoming cash was reduced. There were a couple of other things but that’s enough to be going on with.

Worse, when we put a cash flow forecast together, it demonstrated that it wasn’t going to get any easier unless something changed.

There are five basic elements to managing cash flow:

  1. Gross profit (Revenue less cost of goods purchased)
  2. Customers debt to you and how quickly they pay you
  3. Your debt to your suppliers and how quickly you pay them
  4. Your inventory of unsold stock, and how long it stays on the shelf
  5. The level of your overheads, being the costs you incur whether or not you actually sell anything at all.

If you manage your cash flow by managing each of these items in turn then you will maximise the cash in your bank account for the amount of business you are doing.

So what can you do? Let’s look at them in turn:

  1. Maintain or preferably increase Gross Profit. Discounts and reduced prices reduce profit dramatically
  2. Make sure that you keep on top of chasing debts; put a cash collection system in place, and monitor cash outstanding regularly; if it’s not measured it’s not managed.
  3.  Your debt to your suppliers can be managed by not paying the supplier until the due date for the goods, nobody really thanks you for paying early.
  4. Monitor the length of time stock stays on your shelf; reduce stock holdings and reorder quantities while making sure that you have sufficient to service your customer’s needs. Look at categorising your stock into core items of which you sell a lot and which you need to be able to supply quickly, and those items which you can afford to deliver over a slightly longer lead time.
  5. Reduce your overheads by reducing staff levels to what is really needed, negotiating rates for utilities, reduce administrative costs such as sending invoices by email rather than printing on paper and then sending by post and so on.

The most important thing is to forecast what your cash flow will be and then plan your business strategies around that.

If you would like to understand your financial model a little better why not take advantage of our FREE Finance Review where we come along and spend a couple of hours of our time understanding your business, it’s financial challenges and explain how we help you solve them. Simply emailor call and we will do the rest.

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