The word in business is profit. The word is simple to understand. Companies are considered a success, if they generate profits. For small business, however, profits do not necessarily equate to healthy cash flow or even success.
The accounting definition of profit is sales(including credit sales), less expenses. The oversight of the important aspects of "profitability", leads to numerous problems for business owners.The problem with accounting is that assets purchased cash, will reside on the balance sheet, and inflate the profits, artificially,by the very same amount, that the asset was purchased for.
Invoiced credit sales are recorded in sales journals, and a corresponding debit(debtor), is raised for those credit sales. Value Added Tax or general sales tax is charged on that invoice as it is processed.
One major shortcoming in small business, is the lack of credit control. Many business owners lack the skills to collect outstanding debts. Where VAT or GST has been charged, it become payable, regardless of whether the debtors invoice was paid or not. Businesses also pay tax on profits.
Business owners(on the advice of their accountants) are profit driven, and not cashflow driven. This leads to certain interpretations of their finances. If assets exceed liabilities(solvency),current assets, exceed current liabilities(liquidity), they happy. Business owners consider the available amount on their overdraft or business credit card facility as CASH AVAILABLE! Its not available cash, but debt!
Solvency or liquidity should be measured by the amount available cash(bank and cash on hand), exceeding liabilities. All other assets should be be excluded. The reason is that assets ,could be sold far below their market value, if the business had to be liquidated. Cash is the only asset that can be used, without incurring a cost or loss, on conversion.
What about the cash flow statement? The cash flow statement is not compulsory for small businesses, but is viewed is an important tool, for analyzing the business's cash flow. Many tax authorities accept only the income and expenses account. But even the cash flow statement has its flaws. Loans advanced will reflect as "cash from financing activities", thus creating the illusion that the "healthy Bank Balance", means the business is healthy. In an environment of high interest rates, the loan can be risky, and that aspect has to be factored into the reporting. A note on the financial statements, is not sufficient.
Many accountants might not agree, with the above. But its my firm belief that thorough cash management is lacking in most small businesses. Accounting financial statements should only be used for tax or statutory purposes.
A cash flow driven business would operate as follows:
* Collect outstanding debtors as soon as possible(The most difficult and problematic, I agree)
* Take substantial cash deposits from customers, before commencing a project
* Bank cash promptly, since cash gets lost or spent very quickly
* Stall creditors, as long as possible
* Start investing 5 to 10% of cash received in a particular month, in different bank savings accounts
* These banking accounts also known as reserves, can be called:
a) A Building Fund(For future expansion)
b) A Tax fund and lastly an Emergency fund (Any emergencies that may occur).The reserves can also be augmented by additional sales, the value of credit card payments, that have been paid up. (Would not hurt, since you used to those monthly credit card payments)
* Before spending cash on any expense, apart from salaries, funds should be set aside for the "reserve accounts"
* The benefits of the reserve accounts are two fold, 1) It creates a buffer, between income and expenses(will exert pressure on overheads/spend less), and 2) The business will gradually build capital in reserves, that the business would have had to source somewhere else, if the need arose.The reserves would grow rapidly, if it remain untouched, for say ,twelve months. This exercise requires discipline, for it to work.
Focus on the cash balance and savings, will ensure a rapid (almost magical) growth of cash! The business will also become less reliant on loans, credit and capital from outsiders.
The accounting definition of profit is sales(including credit sales), less expenses. The oversight of the important aspects of "profitability", leads to numerous problems for business owners.The problem with accounting is that assets purchased cash, will reside on the balance sheet, and inflate the profits, artificially,by the very same amount, that the asset was purchased for.
Invoiced credit sales are recorded in sales journals, and a corresponding debit(debtor), is raised for those credit sales. Value Added Tax or general sales tax is charged on that invoice as it is processed.
One major shortcoming in small business, is the lack of credit control. Many business owners lack the skills to collect outstanding debts. Where VAT or GST has been charged, it become payable, regardless of whether the debtors invoice was paid or not. Businesses also pay tax on profits.
Business owners(on the advice of their accountants) are profit driven, and not cashflow driven. This leads to certain interpretations of their finances. If assets exceed liabilities(solvency),current assets, exceed current liabilities(liquidity), they happy. Business owners consider the available amount on their overdraft or business credit card facility as CASH AVAILABLE! Its not available cash, but debt!
Solvency or liquidity should be measured by the amount available cash(bank and cash on hand), exceeding liabilities. All other assets should be be excluded. The reason is that assets ,could be sold far below their market value, if the business had to be liquidated. Cash is the only asset that can be used, without incurring a cost or loss, on conversion.
What about the cash flow statement? The cash flow statement is not compulsory for small businesses, but is viewed is an important tool, for analyzing the business's cash flow. Many tax authorities accept only the income and expenses account. But even the cash flow statement has its flaws. Loans advanced will reflect as "cash from financing activities", thus creating the illusion that the "healthy Bank Balance", means the business is healthy. In an environment of high interest rates, the loan can be risky, and that aspect has to be factored into the reporting. A note on the financial statements, is not sufficient.
Many accountants might not agree, with the above. But its my firm belief that thorough cash management is lacking in most small businesses. Accounting financial statements should only be used for tax or statutory purposes.
A cash flow driven business would operate as follows:
* Collect outstanding debtors as soon as possible(The most difficult and problematic, I agree)
* Take substantial cash deposits from customers, before commencing a project
* Bank cash promptly, since cash gets lost or spent very quickly
* Stall creditors, as long as possible
* Start investing 5 to 10% of cash received in a particular month, in different bank savings accounts
* These banking accounts also known as reserves, can be called:
a) A Building Fund(For future expansion)
b) A Tax fund and lastly an Emergency fund (Any emergencies that may occur).The reserves can also be augmented by additional sales, the value of credit card payments, that have been paid up. (Would not hurt, since you used to those monthly credit card payments)
* Before spending cash on any expense, apart from salaries, funds should be set aside for the "reserve accounts"
* The benefits of the reserve accounts are two fold, 1) It creates a buffer, between income and expenses(will exert pressure on overheads/spend less), and 2) The business will gradually build capital in reserves, that the business would have had to source somewhere else, if the need arose.The reserves would grow rapidly, if it remain untouched, for say ,twelve months. This exercise requires discipline, for it to work.
Focus on the cash balance and savings, will ensure a rapid (almost magical) growth of cash! The business will also become less reliant on loans, credit and capital from outsiders.
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