How Profitable Businesses Can Go Bust

How can a business making plenty of sales possibly go bust, you may wonder? The answer is cash. Your cash can be in a surprising number of places other than where it belongs – in your account.

Cash is often the reason so many businesses fail. Profits can’t be spent until they are collected. If you don’t focus on collection, your business won’t last very long.

Cash is the lifeblood of any business and if it isn’t flowing at the right place at the right time, it can cause real headaches for the business owner.

An age-old question accountants get asked by business clients is “How come I’ve made a profit but I don’t have any cash?”

So, what causes cash-flow problems? The answer lies in the issue of the cash-flow cycle. The cash-flow cycle is often overlooked by small business owners until business starts to grow and they experience ‘cash-flow squeeze’.

• Before you can sell anything, you have to buy something i.e. stock or labour.
• Depending on your sales cycle, how long the stock sits in store, for example, you may hold on to stock for 60 days.
• Depending on the terms you get from suppliers, you may have to pay for that stock after 30 days, which means you have 30 days negative cash-flow.
• Depending on your accounts receivable management you could wait 60 days to get paid, which adds another 60 days negative cash-flow.
• This adds up to 90 days negative cash-flow.

This means your money has been somewhere other than your bank account for 90 days i.e. in the bank account of your supplier and your customer. This is referred to as ‘funding the sale’.
This is also known as ‘working capital’. Working capital puts you in the position whereby you have to have a certain amount of money to fund sales.

This causes problems when growth occurs, because the issue just gets bigger.
If your business isn’t working to minimise the number of days stock is in store and the number of days customers are taking to pay, the cash-flow problem gets worse when sales grow.
Sometimes, businesses get very focused on increasing sales and the issues of stock movement and accounts receivable get ignored. This is why growth can often kill what appears to be a good business.

A lot happens to cash on its journey from the sale to your bank account. If you are planning to grow your business, you must understand this phenomenon or you could be heading for cash-flow problems.

For assistance with cash-flow management and financial forecasting, call Tradies Accountant today.