What's More Important, Cashflow or Profit?
A question that often arises during conversations with clients is whether it is more important to ensure that the business is profitable, or that it is has a strong cashflow. The truth is that one should usually lead to the other; the more profitable your business is, the better your cashflow should be.
Of course, that doesn’t always follow suit. There are many situations where profitable businesses overstretch themselves financially and end up struggling to survive. On a simplistic level, the answer appears to be that cashflow is more important than profit as without cash the business cannot survive! It is however a bit like the chicken and the egg – you need to be profitable to generate cash, however without cash you do not have the resource to generate profit.
Having systems and documenting operations, should ensure that profitable businesses properly manage their cashflow. That includes the following:
Debtor collection – without collecting the money you are owed from customers you will fall at the first hurdle! Make sure that you have a documented debtor collection system with set procedures to ensure that you are paid on time.
Invoicing – ensure that you have documented procedures for when you invoice your customers. If it is a large job that will take several weeks to complete, you should be looking to invoice on account to cover your costs in the interim period. The same applies if you are required to commit to a large order of goods to supply, ensure that the customer covers the cost at the start, to avoid you having to foot the bill.
Regular financial reporting – having monthly or quarterly management accounts (including cashflow) is essential in ensuring that the business doesn’t run into trouble. If it is starting to, you will be able to spot the signs much earlier and deal with them. You should also prepare budgets to compare your actual numbers against, to enable you to identify where you have overspent and factor that into your future cashflow.
Supplier accounts – negotiate accounts with your regular suppliers. Even if that is 30 days credit, it is better than having to pay in advance or on delivery of goods and services.
Multiple bank accounts – ensure that you have not only a current bank account, but also one for your corporation tax, VAT, PAYE to ensure that you have sufficient sums set aside to pay your taxes as they arise. You should make transfers (weekly/monthly) to your tax accounts, as not only will that ensure that you don’t get into trouble with the tax man, but you will also have a better picture of what your real cash position is, by what is left in your current account.
Look at borrowing options – that may be factoring or invoice discounting to assist with day-to-day cash, or a bank loan to assist with growth. Prior to borrowing, make sure that it is affordable by building it into your financial reporting.
As your business grows, making sure that you review your cashflow regularly becomes even more important! Prior to making decisions, build a forecasting model which allows you to flex the numbers to see what the business would look like if turnover increased by 20%, as that may mean you will need to incur additional overhead in terms of staffing, office space etc. Would you be in a better cash position than you are now, or are you better off remaining where you are for the time being?
In summary, cashflow is more important as ‘cash remains king’. Without having cash in our business, it cannot continue to trade and grow and increase its profit. That is not to say that being profitable is not important though, as I mentioned at the start, they should really go hand in hand!
If you would like to discuss any aspect of this article or for any other tax, business and accounting advice, please email Adam Moody at adam.moody@raffingers.co.uk or click here to get in touch.