You know the saying “sales are vanity, profit is sanity”, it is my view that this little sentence should end with “cash is absolutely essential”.
Businesses do not fail because they don't make profits (at least, not immediately), they fail because they run out of cash. Once it’s gone it’s gone.
As the pre-recession cash wells have all but dried up, keeping what you have, and squeezing the last drops out of your assets, is more than desirable, it’s essential for survival. So, first things first, are you fully exploiting your key assets of stock and debtors? In other words, do you have optimum stock levels and are you collecting as promptly as possible?
Try this simple formula to work out what each day tied up in stock and debtors is worth to you. You may also like to check if you may just be paying too quickly. I call it the RIP ratio so try ripping into your assets.
It’s vital you know how much cash you are creating, the example below shows you how to calculate this, do it every month.
This Free Cash Flow (FCF) is a vital tool; it shows you what free cash the business can generate after maintaining, or expanding, its asset base. To assess what cash you have actually created, you need your balance sheet for the beginning and end of the period under examination. Then use the following basic formula (it is not fool proof, but is a good and simple technique):
Net Profit + Depreciation:
- - Increases (or + Decreases) in Debtors
- - Increases (or + Decreases) in Stock
- + Increases (or - Decreases) in Creditors
- - Decreases (or + Increases) in Bank Loans / Overlays
- = Net Cash Flow
And finally, make sure you know the difference between profit and cash, they are not the same!