We’ve all heard the saying “cash is king, profit is sanity and turnover is vanity”, but have you ever stopped to think about what this really means? Here, Grid Law founder David Walker explains how to achieve profitability by unlocking the cash in your business.
When I ask entrepreneurs about the most important attributes of a successful business, many of them will talk about the business being as profitable as possible.
Now, there’s no denying that profits are important, but as the saying goes, profits are only sanity. Profits are just a line on your accounts. A theoretical amount which is left over when (in simple terms) you subtract your expenses away from your revenues.
You can’t spend profits, you can only spend cash, and this is why cash is king. Unfortunately, many entrepreneurs completely overlook this and cash reserves are rarely, if ever mentioned.
When a business has available cash reserves, it can:
- Re-invest for growth
- Re-pay debts to reduce its liabilities
- Pay the owners a dividend so they can reap the rewards of all their hard work
When a business is in financial difficulties, changing the focus from generating profits to generating cash can be the deciding factor in whether or not it survives.
On the other hand, even profitable businesses can be forced to close if they run out of cash. I’ve seen business owners completely bewildered about what went wrong because they thought everything was going well. They didn’t keep an eye on their cash flow and had no idea that the end was in sight.
So, how can you unlock the cash in your business?
Many business owners think there are just two ways to increase the available cash in their business – increase sales and decrease costs. But there are actually five keys to unlocking more cash in your business and these are what we’re going to look at now.
More sales equals more cash provided you’re selling at a profit and your clients pay (see more on this below), so increasing sales will lead to more cash in your business.
You can also increase prices so more cash is generated from each sale.
Most business are very good at increasing sales so this is where they focus their efforts. When sales are increasing you quickly see tangible results and the business has a buzz of excitement around it.
However, increasing sales, as effective as it is, shouldn’t be looked at in isolation because sales and “busyness” don’t always mean more cash.
When your business is making healthy profits, you’ll probably spend as much money as your business needs because it seems like it’s being put to good use.
But is it?
When you’re busy and the business is growing, it’s easy for it to become inefficient. You can lose track of your spending as different departments demand bigger budgets to keep pace with their rate of growth.
This is the time you should be keeping a close eye on costs because increasing overheads can soon drain your cash reserves. Then, you only need a slight down turn in trade to turn your cash flow from positive to negative.
Turbulent times are when most business owners think about cutting costs as a way of saving cash, but even during the good times running your business as lean as possible is a great way of increasing the amount of available cash.
Decrease your inventory or stocks
If you run a retail business, money is tied up in the stocks you have sat on your shelves or in your warehouse. So, you need to keep them as low as possible. However, you need to strike a balance because if you don’t have sufficient stocks you could miss out on sales if your products are unavailable.
Therefore, you need to look at your supply chain management. The quicker your suppliers can deliver, the less stock you need to hold.
If you run a service business this is obviously going to be more difficult, but you will still hold stocks of some items. For example, think about your office consumables. With suppliers offering next day delivery, there’s probably more money than you think sat in the stationery cupboard.
Increase your accounts payable
Accounts payable is the amount of money your business owes to its suppliers. Increasing the length of time you take to pay a supplier, increases the amount of cash that is available in your business so you can prioritise what you spend it on.
Now, I’m not suggesting for one moment that you pay your suppliers late! What I’m saying is that there are other ways to increase your accounts payable.
For example, have you ever tried negotiating longer payment terms? This is controversial and many large businesses are criticised for increasing payment times to small businesses, but you can’t argue against their logic. They’re increasing the amount of cash available to them so they can decide how to spend it.
Even if you can’t agree longer payment terms, there are other ways of increasing your accounts payable. For example, you may be able to agree payment in instalments, rather than one lump sum.
Alternatively, you could finance larger payments. You’ll have to pay interest on the loan, but by spreading payments in this way you could make more cash available for other purposes.
For smaller items, you could use a credit card and may even be able to earn cash back on it or loyalty points to spend on other purchases.
Decrease your accounts receivables
Accounts receivables are the amounts owed to you by your clients.
When it comes to unlocking the cash in your business, this is the big one which often gets ignored. But, if you can make improvements here, you can transform your businesses.
Late payment is a huge problem faced by over 60 per cent of businesses and it’s getting worse.
In my experience, decreasing your accounts receivables, is the single most effective way of increasing the available cash in your business. This is because most business owners overlook it as something that isn’t within their control.
Getting paid the money you are owed is always within your control. As a business owner, you can always improve the efficiency of your credit control systems and you can always take a proactive approach to recovering overdue invoices. To find out more about this, take a look at my previous article: An effective guide to tackling unpaid invoices.
Please remember that a business with healthy cash reserves is always going to be more secure and more valuable than an equivalent business without. So, unlocking the cash in your business is an important strategy that you should be focusing on.
If you have any questions about anything I have covered in this article or any other legal questions about your business, feel free to email me at email@example.com and I’ll happily answer them for you.
Catch up on some our favourite David Walker articles:
- Five early warning signs that your client is in financial trouble
- Why too much investment in marketing campaigns could kill off your business
- How to settle a dispute before taking the case to court
Sign up to our newsletter to get the latest from Business Advice.