The “Money in Money Out” equation!
Just as the fitness industry uses the ‘Energy in, Energy out’ equation, the cash flow of your business comes down to the ‘money in, money out’ equation.
In an ideal world it would flow regularly in and out with no shortage of supply however, there are many factors that impact the income and expenditure of a business and whether or not your business is fit and healthy enough to stay afloat.
I’m sure you have heard of the term ‘profit and loss’ and possibly even the what the balance sheet says about your business but do you know how crucial the cash flow is to your business? I have said it before, and I will say it again, “Cash flow is the HEART of any business.” It is the money in the bank. It is the money that leaves your bank and the money that arrives in your bank. Sure, the bottom-line figure of the Profit and Loss is important but if you make the mistake of focusing entirely on this number only then chances are, you will come unstuck somewhere along the way.
You need to manage both effectively as ignoring cash flow can potentially ruin your successful plans for profit. Your cash flow can be affected by many things. I have listed a few below:
• Not invoicing regularly
• Late payment from debtors
• Not having systems in place to follow up on overdue debts
• Mismanagement of drawings from business
• Not having a personal and/or business budget
• Paying suppliers earlier than necessary or being unable to negotiate longer trading terms
• Purchasing inventory that is not sold on in a timely manner
These are the ones we see trip up most business owners but to get a more accurate picture it would be necessary to drill down into the financial reports and pinpointing possible areas of concern.
Understanding all the reports and learning what they mean for your business can be tricky and time consuming however, to assist you to understand the basics I have condensed them below.
Profit & Loss (Income Statement) – shows revenue (cash in) and expenditure (cash out). Take the expenditure from the revenue and you either have a profit or a loss. From this report you can establish if you are overspending in some areas or not bringing in enough revenue. It would be ideal to run this report at least quarterly to help keep your business on track.
Balance Sheet (Statement of Financial position) – a summary of all your business assets and liabilities. It shows you how much money you would have left over if you sold all your assets and paid off all your debts (liabilities). This figure is known as ‘Owners Equity’. If you were to apply for a loan this is one of the reports the lender will require and from this report, they will work out your ‘debt to equity’ ratio.
Debt to Equity Ratio – A good ratio is around 1 to 1.5 and you can calculate this by dividing your liabilities by your equity. For example, if you owed $75,000 and you had $60,000 in equity then your debt to equity ratio would be 1.25.
Remember profit is important but so is the amount of money you have in the bank and if you are wanting to apply for finance of any kind then having a healthy cash flow and an adequate profit will put you ahead of the game.
Keep your business fit and healthy because, like your body, it will carry you through many years if well looked after!
If you are struggling to manage this side of your business, then do yourself a favour and outsource it to a reputable BAS Agent/bookkeeper. Bookkeeping is so much more than just data entry and a good bookkeeper will most definitely be an asset to your business.