The two main litmus tests for a business owner are how sales are tracking and how much cash is coming into your account. Accountants and bankers worry about Net Profit, a mysterious number that appears on your financial statements every quarter. This never seems to reflect the money coming in and seems to just serve a function that tells you how much tax has to be paid. Why is this? What is the relationship between profitability and cashflow?
Businesses should be rightly proud when in a high growth phase. When your business is growing at 10% or 30% or 50% per annum when the market is growing at 3%, it shows you’re doing something different, which is one of the reasons why you went into business in the first place. Paradoxically though, a period of high growth can cause your cash balance to drop.
The reason for this is the cash cycle, which varies business to business and industry to industry. Your suppliers will have terms, your goods may take time to manufacture, or it may take time to do the work you’re getting paid for. In an ideal world, you will receive your product or complete your service and get paid for it in time for your supplier to get paid, making a tidy margin. Unfortunately, this is not always the case. Sometimes your cycle can be long. Goods can sit on a ship for a long time, and you have had to pay for them when they left the port. You might have a staged project which costs a lot of money up front, but you’re getting paid for in parts as key deliverables are met. You may have provided favourable terms to a client to get a sale, and they don’t have to pay you for 3 months after you send them your product.
In all these cases, and many others, your receivables cycle is longer than your payables cycle. Before your eyes glisten over, this simply means it takes longer for you to get paid than you need to pay for whatever it is your company does. This means you’re getting paid for the lower sales you made a few months ago whilst paying for the goods you need for increased sales happening now or in the future.
If the cash gap is small enough or margins are high enough, this can be covered by profitability, but the problem can blow out quickly by things like shipping delays, reduced margin, favourable terms given to your customers and accelerated growth.
So what are you supposed to do? You can limit your sales and miss opportunities, and indeed this is a viable option, where you pick the highest margin clients. The other option is a cash flow solutions provider. Cash flow solutions providers understand the relationship between profitability, growth, and the business cycle, and look to fund a high growth phase or individual large contracts, allowing you to make sales and manufacture or import the goods, or hire staff and complete the work you have ahead of you. There other advantages of using a cashflow solution over traditional funding:
- Cash flow solutions allow you to realise your profit as cash rather than future receivables.
- Most finance is backward looking and looks at profit functions. Cash flow solutions are forward looking and look at cash flow forecasts.
- Traditional finance looks to secure debt using real estate. Cash flow solutions are often secured by your business income rather than real property.
- There non-cash products such as letters of credit which allow a bank to guarantee payment to an overseas supplier when certain deliverables are met, such as the goods arriving on-shore, creating a lower risk transaction for buyer and seller and meaning you don’t have cash tied up in goods in transit.
Here to lend a hand if your business is experiencing any of these challenges. Reach out if you’d like to discuss further.
