Profits are "Liabilities"

For my birthday this year, I want my business to grow by 50%. Would you like one of those birthday presents too? Ok that can be organised, but what about next year?

Ah, yes, of course we actually want our businesses to continue to grow next year and the year after. If your business is growing by more than a modest inflation-like rate or thereabouts, there is one key “factor” you MUST continually address:

Cash Flow

Profits are a Liability

 

"Readies"

The one factor that stifles and destroys growing businesses more than any other is money -- “readies” that you have available day to day. Or, to be more accurate, the lack of it.

There are millions of stories around the world of businesses that experienced fabulous growth that were the darlings of the investment community. Companies that had “The Next Big Thing,” with profit levels to make every other business owner green with envy, issuing staggering forecasts and failed. Large and small businesses just like yours.

If your business is going to grow, heed this warning and heed it well: If you do not plan for cash, you will not have it when you need it.

Even if you somehow survive that crisis, it will cost you an arm and a leg, not to mention years of your life!

A business cannot grow unless you feed and water it with money. When you grow a pot plant, it will outgrow its pot when the plant increases in size by 25%. A business is just like that: As the business grows 25% or more, it will need a different pot of money to feed from. The ferociously growing business will soon dry up your own resources and those of your partner, and your parents etc.  What you might have been able to finance through your own funds, a personally guaranteed overdraft, credit cards, and cheap money like 30-day trade accounts with suppliers, is suddenly ravenous for more.

Your P&L

It can be extremely tempting to look at a Profit and Loss (P&L) printout from your bookkeeping program and be lulled into a sense of security because you are showing a healthy turnover and great profit levels, talk about an aphrodisiac! But profit means very little, it is purely a number on a piece of paper, and bears virtually no relationship to your bank account or your ability to pay people and the sustainability of your business.

Bad News

In fact, net profit in your company is a liability! Let me repeat that in case you did not get it: Profit in a growing business is BAD NEWS!

Come again? How can that be? Well that is very simple: Net profit means you have to pay tax, and that means taking money out of the business and sending it to the ATO. Don’t get me wrong -- I am all for a healthy tax system, I like the fact that I was able to spend a week camping in a National Park over Christmas, all paid for by the tax system.  However, it is your job to build a sound and healthy business, one that will pay its taxes for many years to come, not just this year. Making profits in the growth phase of a business simply means you will be drawing money out of the business that you will have to replace from somewhere else.

Key ingredient

That means that there is one key ingredient to the recipe for financial success of a growing business and that is the implementation of a properly organised cash-flow management and forecasting system.

To be able to do cash forecasting, you cannot rely on your bookkeeping system alone, at least none of the ones I know. It requires the use of your brain, primed with the information, reports and other data you get from your bookkeeper and bookkeeping system.
Cash flow forecasting is a bit of an art and by its nature can be somewhat rubbery, and that is exactly why many businesses put it in the “too hard” basket. But by doing it regularly it will become more accurate, easier and take little time.

The essential principle is simple. It requires a spreadsheet to set it up. You can buy spreadsheet templates that will do the job for you and that is a reasonable option. There are also some resources for cash-flow management on The Ten Truths website (see links below). Of course, you can also get external help: your bookkeeper, your accountant or your business coach will all be able to help, assuming they know their trade.

The basic principle of cash-flow forecasting and management is this:

  • Start the bank balance on day 1 of month 1.
  • Deduct what you reasonably expect you will have to pay during the month.
  • Add what you realistically expect (not “hope”) to be paid during the month.
  • Calculate the bank balance by the end of the month.

Next month:

  • Add closing balance of month 1, as opening balance of month 2
  • Repeat the process above.
  • And so forth for every month of the year

Simple really. Of course as your calculations get further into the future, there will be a fair bit of guesswork involved. But even allowing for that, I promise you that you will gain some great insights into your business.

So go on... Grow your business but take your cash seriously starting today. Your business will be so much more FUN, I guarantee it!

 


Roland Hanekroot

Founder at New Perspectives Business Coaching

I'm a small business coach, mentor, and author on a mission to help Family business and small business owners build Great Small businesses and make Business Fun. Download my book for free at: http://funinbusiness.biz

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