Most business make money. Few have anything to show for it at the end of the year.
If you’re anything like me, you’ve found yourself looking at your profit at the end of the month, quarter, or year and wondering: where’s it all gone?
The key to understanding where it’s gone is knowing the difference between profit and cashflow. Once you’ve got that sorted, you’ll be able to manage your working capital cycle so you keep more of your cash, in your bank account, for longer.
In this article, we’ll uncover where your missing profit is hiding.
What’s in it for you?
Before we get into things, I’d like to share the experience of a recent customer. They had a bottom line profit of $70,000 for a three-month period. Over the same three months, their bank balance had gone from plus $30,000 to minus $10,000.
Needless to say, they were a little dumbfounded as to where the $70,000 profit had gone.
Our next question to them was “would you like to turn the negative $10,000 to positive $50,000?”. Unsurprisingly, their response was “of course!” We spent the next six months working together to create a plan to fix their working capital cycle. Within the following months, they saw their bank balance increase to an excess of the targeted $50,000.
Where your profit goes
Let’s go back a step. Before our client could reach their $50,000 target, they needed to understand the fundamentals of the working capital cycle.
Put another way, your working capital cycle is the hole that your profit disappears into.
In simple terms, it goes something like this:
- You set up a business
- You buy some plant and equipment
- You buy some stock/employee’s time
- You sell that stock
- You pay for some overheads
- You get paid for selling your stock
- You take the profit from selling your stock and reinvest it or take it out as profit
Those steps are the working capital cycle. Well, the short version anyway.
Profit then gets reinvested in your business, and then sits in the pockets of staff after wages are paid for unfinished work. It sits with customers who haven’t paid the money they owe you. It sits in the new machinery and computers, purchased with profit and not through correct debt funding. It sits on shelves which are overstocked. It sits in plain sight, but is typically forgotten about.
To get more of your cash faster, it boils down to speeding up your entire working capital cycle so that your profit spins through your business more quickly. The faster it spins, the more of it you get to keep in your bank. The slower it spins, the slower you get your hands on your cash.
Three ways you can get more cash:
The biggest driver of working capital is routine. People tend to pay bills, and themselves, when they’re able to—not when they plan to. Getting a routine into chasing people to pay you, and paying people you owe, can revolutionize cashflow.
Businesses usually have far more stock sitting on the shelves than they expect. If you’re a retailer or manufacturer, stock is what you think it is –it’s the things sitting on the shelf unsold. How much of it could you not repurchase, or sell at a discount to get cash in?
If you’re a service provider, your stock is the unfinished job which you can’t quite invoice. You’ve paid your staff wages, but they haven’t finished the job, meaning you can’t get paid. As an aside, we’ve recently worked with an architecture business to drop their stock from 97 days’ worth of unfinished jobs to 23 days (the technical term is “work in progress” or “lock up”).
Equipment is often financed incorrectly. A business will have a good month, and rush out to buy the computers and equipment they desperately need. There’s no issue with the purchase itself, just how it’s paid for.
They’re buying a long-term piece of equipment from short-term finance. When other short-term debt comes due for payment, they simply don’t have the cash to pay for it (because it’s tied up in their long term equipment).
What to do right now
Right now though, here’s four things to try in your business to improve your cashflow:
- Set a target for your cash balance at the end of the current quarter. Share it with someone.
- Look at your working capital cycle, and calculate how many days other people are sitting on your cash for (for example, on average how many days does it take for a customer to pay you).
- Revisit your processes for managing that aspect of your working capital. Tweak, monitor and improve constantly throughout the quarter.
- Compare the before and after measurement of the number of days other people had your cash for. For example, are people now paying you in 27 days rather than 35 days previously? If so, then the experiment has worked.
For more help on building your Working Capital, and understanding where you missing profit has gone, check out our resources here.
Otherwise, feel free to get in touch for a no-obligation session to discuss your working capital cycle.