Where Art Thou Cash?

Written by David Maher from Right Brain Insights.

Have you ever found yourself wondering ‘where is the cash?’ You have seemingly ‘made all of this profit,’ yet when you check your bank statement, it feels like someone has ransacked the cookie jar… 
If so, you’re not alone. This is a issue we encounter in the beginning with nearly all of our clients. The heart of the problem is confusion around how profit does not equal cash flow. While profit is a part of cash flow, they are absolutely not the same thing.

Put it this way – profit is relatively easy to understand. In our experience, even for the owners of quite large businesses, they’ll have quite a solid grasp of their profit. If you think about it, the mathematics is simple:
Income – Costs = Profit. The brain can easily handle this.

The issue comes with cash flow. Why? Well, profit is a part of cash flow, but it is not the whole equation. Cash flow is made of of ALL movements IN & OUT of ALL accounts at different TIMES. Every business is different, but think about it like this.

  • Profit has 2 moving parts. Income & Costs.
  • Cash Flow has 5 moving parts. Income, & Costs, but then… Assets, Liabilities & Equity.

It is the movements in assets, liabilities & equity that DO NOT sit in the profit & loss statement, but do flow in & out of the bank, that cause a variance between profit & cash at bank.

To help illustrate this, have a look at the image below.

Here we have FY15 profitability on the left & cash flow on the right. See how EBIT (earnings before interest & tax) is $685K, yet net cash flow is $113K. Roughly 1/6 of the profit result!



How can this be? Well from top to bottom we can see what the money was sucked up by;

  • $83K net change to the tax man, cost of civilisation.
  • $51K decrease in the level of what is owing to suppliers.
  • Accounts receivable increased by $152K, selling things without being paid. That’ll create profit alright, but not love in the bank.
  • Stock levels increased by $151K, similar to receivables, this stock must be sold to realise it’s value in the bank.
  • Then there’s $206K on fixed assets. This could be say investing in new machinery.
  • Financing cost increase of $194K. Probably a result of all of the above. These things don’t just pay for themselves…
  • Interestingly, can you see how this company, could add nearly $300K to their cash levels through tighter management of their receivables & inventory alone…

So what are some of the common movements in assets, liabilities & equity?

When it comes to trade service businesses, it is often they will struggle to pay invoices on time. Suppliers & staff need to be paid, but it takes time for you to be paid. This can cause quite lumpy cash flow, especially if payroll is weekly (typical in the trade sector), yet most payments arrive via a monthly claim cycle.

For businesses with a large equipment base, or perhaps a manufacturing focus, cash flow can be driven by receivables, but also by movements in stock & materials, plus finance payments on loans.

We have also come across trade businesses with incredibly tight cash flow, not due to receivables, stock, or any of the common issues. It actually relates to how much cash is being sucked out by the owners. In effect their lifestyle choices are slowly killing the business. It’s a classic case of slaughtering the goose that lays the golden eggs.

Finally, a particular large contributor to cash flow pain in our experience is compliance & tax. Many businesses either underestimate, mis-manage, or do not fully understand, their tax obligations. This can land them in quite hot water when ‘the man’ sends the bill for the cost of civilisation.

The point here is to understand what your primary drivers of cash flow are in your business. Every business is different, but if you can understand what matters to you, seek to optimise this in your business in as many ways as possible.