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Why cash flow counts in business

There’s a saying in business, “You can go broke making a profit.” And another, “Cash is king. Profit is theory.” You can’t pay rent, meet payroll or pay your bills with profit – you pay them with cash.

We caught up with Shannon Smit, chartered accountant and qualified Financial Advisor with SMART Business Solutions who knows how getting the technical stuff right is critical for business success.

Shannon says “A business can make a lot of sales, have a book full of orders, have delighted customers and clients, have a great reputation, be growing, and yet still go broke. Why? Cash flow.”

The business might be profitable on paper, but have no money left in the bank. They become insolvent. A growing business is often hungry for cash… hungry for inputs so it can make the business’ outputs, be they physical products, services or a combination of both.

The tragedy in this is that cash flow crises can often be averted. They can be predicted, planned for, and then contingency measures put in place. Shannon shared her top five tips for local businesses to strive for when managing their business cashflow. Let’s get started!

1. Know your cash conversion cycle

Your cash conversion cycle is how long it takes from when you outlay cash to say your supplier, through to when you receive the cash from a customer. For example, let’s assume you purchase from your supplier and they sell on 14 day terms, and on average you hold your stock for 30 days before it is sold. You make the sale and allow your customers 30 days to pay, your ‘cash conversion cycle’ is -14 + 30 + 30 = 46 days. This means you need enough cash (working capital) to fund 46 days.

2. Prepare a cashflow forecast

It doesn’t have to be a masterpiece but take the time to consider what your anticipated sales are, when you will get paid, what your upcoming expenses are, and when are these payable. Start with your opening bank balance for next month, add the expected cash inflow from sales (could be prior month depending on your terms with customers) and subtract your cash outflow from payments for things like staff, stock and expenses to result in next month’s closing bank balance.

Do this for the coming 12 months to proactively identify any potential issues.

3. Put money aside for GST and income taxes

GST is not revenue or expenses so it doesn’t impact your profit, but it has a huge impact on cashflow. GST is not your money, just think of yourself as a ‘free’ tax collection agency for the ATO. You are collecting GST from customers on behalf of the ATO, and you subtract from this your GST paid. Your accountant can assist you in identifying an approx. percentage to set aside each month in a separate bank account.

Often those new in business or in a high growth phase are adversely impacted by cashflow challenges when these unexpected tax bills arise.

4. Invoice on a timely basis and chase any debts overdue

You cannot get paid if you haven’t invoiced! You may be busy with ‘doing the work’ but you should aim to invoice when you finish the job, or set aside a time each week to invoice. And as they say, the squeaky wheel gets the oil so make sure you are proactively chasing monies owed through regular follow up.

Consider using the automatic email function within your accounting software.

5. Know your margins and break-even point

It is critical that you understand your margins, what are your direct costs for the products you sell or services you provide (often called the ‘Gross Margin’), and how much do you need to sell so you generate enough profit at the gross margin level to pay all your other expenses? This is called the break-even point.

Remember that you are running a business, so don’t forget to pay yourself, and therefore you need to see profits above the breakeven point.

Meet our Local Expert: Shannon Smit – SMART Business Solutions, Mornington

Close up of smiling Shannon Smit from SMART Business Solutions
SMART Business Solutions Director Shannon Smit, Chartered Accountant and qualified Financial Advisor, thrives on technical developments that enable tax planning opportunities. Shannon is an active and trusted panel member of the Australian Board of Tax Advisory, and the last review she was involved in resulted in the Instant Asset Write Off (from $20,000 to $30,000), a simpler BAS, and an increase in the threshold of a small business to $10 million. If you’re a small-business owner, these are just a few of the tax concessions for which you have Shannon Smit to thank.

Content reviewed and updated January 2024

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