Cash is Reality

You may have heard the phrase: “Turnover is Vanity. Profit is Sanity. Cash is Reality”.

In business this is so true.

Obviously it is good to see a business’ annual income increase or sustain at high levels, but more important than the total revenue is the profit being made on those sales. For example, would you rather run a business with an annual turnover of $10M and a net profit of $100K or a business with annual sales of $1M and a net profit of $100K? With a return on sales of just 1%, the first business is likely having to work harder to earn that profit and with such a low return, runs the risk of making a loss in other years, whereas a return of 10% as in the second case provides for greater investment into the business and greater flexibility in operation being a little less constrained financially. Hence the reason that ‘profit is sanity’.

But even more important than profitability is cash. According to “Score”, 82% of small businesses fail due to cash-flow ( and so you may well be wondering why would a profitable business fail due to lack of cash? The reason is that being profitable and having cash in the bank are not necessarily correlated primarily due to timing.

Let me illustrate by means of a true-life example.

An Australian SME had managed to secure a significant deal with a company in China which I believe was worth in the region of $2M. Typically companies don’t get paid for their goods until the product is received and accepted by the customer which means much of the cost of the raw materials and the labour has to be borne by the supplier up until then. After having covered the costs of the development and raw materials, this particular company found it then had to raise $600K in freight costs. Unfortunately it was unable to do this by the shipment date, so the product did not get shipped when required and the deal was subsequently lost. Soon after, the company itself went into liquidation.

The above example illustrates the point that it is not just about having the cash available, it is also about understanding what money will be coming in and what money will be going out over the coming months. This is what is meant by managing ‘cash-flow’ and in general is not done anywhere as often as it should be by many businesses. There are some significant differences between a cash-flow forecast and a budget since the former is all about what cash will be available whereas the latter is about what profit will be made over the period. Another key element that distinguishes the two is that the cash-flow includes tax so GST will need to be included in forecast revenue and expenses as well as expected BAS and IAS payments and any other tax obligations. I have seen more than one company come unstuck by failing to make provision for these payments especially when the Profit & Loss statement shows a healthy profit. Cash-flow forecasts should always be reconciled with bank statements since they represent the real cash position of the business at the time and may highlight expenses that otherwise may get missed.

There are many ways to generate a cash-flow forecast but for most businesses, keeping the process simple by using a tool like Excel will suffice. The important thing is to get into the habit of doing this on a regular basis so that there are no unpleasant surprises.

Ian Ash is the Managing Director of OrgMent Business Solutions –