Cash comes and goes without much of it going to you. Sound familiar?
Most businesses focus on profit, as well they should, but what happens to your profit is just as important.
It’s true that when businesses grow you have to fund working capital, basically the debtors, but there can be other reasons.
- Do you have another business? An overseas office? A side hustle? A JV? Is it being taken up as an investment (asset) in your balance sheet? Should it be?
- Are your debtors taking longer to pay you? Or are you selling more?
- Do you bill your clients as soon as possible or does it wait a while to get done? Are they on retainers?
Accountants use a report called “source and application of funds” to show this stuff. You can use a simplified version to help understand where the money goes.
Start with your profit then go through your balance sheet and add or subtract:
- any up or down movement in your total debtors (it could be an increase in sales or just a blow out – track your debtor days)
- movement to work in progress (un-billed work)
- investments in side hustles (inter-company loans)
- movement in business loans like debtor finance or overdraft (the undertow)
- amounts owed to the ATO, super and state governments. Are you providing for them properly?
- movement in what you owe to suppliers
- capital expenditure (office fit-outs, technology, equipment)
- is there anything left for you?
The underlying reasons for movements can either be good or bad, not the movements themselves, the main thing is that you understand what’s going on.
And just because your business is producing a ton of cash doesn’t mean everything is fine. It might be just running down. Like plants that flower when they are going to die. Make sure you check your profit too. Make sure it is correct.
If your P&L is lumpy you can bet it’s wrong. Cash, on the other hand, is usually lumpy. Make sure you know the difference.