Business Mentor: Watching your cash pays off

I've had my eye on my profit-and-loss reports, not my cashflow, and have discovered that, while sales are strong, I don't have much cash to work with. Can you give me a few tips on things to look for or do to ensure I've got a good handle on the cash side of my business as well?

Tracey McKeown, director of Urban Accounting, replies:

There are several explanations why increased sales might not equate to increased cashflow. The main areas to review are:

* Cost of sales (margins).
* Expenses or overheads.
* Fixed assets.
* Credit.

Cost of sales

Cost of sales are the costs directly attributable to providing the product or service the business is selling - in a restaurant it would be the ingredients and beverages.

Keep an eye on waste as this results in your cost of sales being higher than necessary. If wastage is a fact of life, you should factor it into your pricing.

Also keep an eye on inventory levels. Inventory equals money invested. If you are holding high levels of stock, this is money spent that you have not yet had a return on. Consider buying smaller volumes of slow-moving items or negotiating a sale-or-return policy with your suppliers.

Watch your sales margin (sales less cost of sales) divided by sales = margin percentage. If your margin is reducing, or varies markedly, this could mean that:

* Pricing of new products should be reviewed.

* Cost of sales may be increasing.

* You have a number of products and the balance between products with different margins has shifted.

Learning how to measure your margin will help you understand your business better.

Expenses

Expenses or overheads are the day-to-day costs of running your business. These include understanding the difference between fixed and variable costs. Fixed costs are incurred no matter what level of sales you have, such as rent and the cost of administration staff.

To calculate the sales required to cover these expenses, total up the fixed expenses and divide by your sales margin (see above). This will give you the amount in dollars you need to sell in order to cover fixed expenses.

Also, when you started out in business, you may not have been able to get a volume or business rate for items such as stationery or printing, so it may be worth reviewing your pricing options if your buying volumes have increased.

Fixed assets

Fixed assets are items bought for the long term such as manufacturing equipment and are often significant enough to impact on your cashflow. Consider leasing and financing options if cashflow is an issue.

Credit

Credit can affect your business's cashflow if there is a difference between the terms you offer clients and those you are receiving. If your clients pay you on the 20th of the month and your suppliers require payment within seven days, you are paying out for sales that have not yet been collected.

Here are some ways to tackle this:

* Talk to your clients about changing their payment terms to the 20th of the month. You may need to provide them with an incentive, such as a discount.

* Introduce credit limits to minimise your exposure to large orders that will destroy your cashflow for the month.

* Ask your clients if they would consider paying you by credit card at the time of sale, preserving the terms on which they are paying but allowing you to get your money faster.

* Talk to your suppliers about moving to monthly payment terms.

* Ask them if they will accept credit card payment as this will increase your payment terms.

* Always invoice clients on time.

One of the most important tools for overcoming a cash imbalance caused by differing credit terms is a strong relationship with suppliers. Your success and their success are interdependent. Lastly, consider cashflow forecasting. This will allow you to prepare for cash shortages.

* Tracey McKeown can be contacted at tracey@urbanaccounting.co.nz or ph (09) 376-2701

urbanaccounting.co.nz