It is interesting over the years the number of times we have had similar discussions with business people around cash and profit. In business we often drive profit. Many businesses tend to focus on the Gross Profit but forget it is a holistic approach that best serves the welfare of the business.

Many conversations are around: ‘’But we are profitable, we are earning good profit.’’ As well as: “You have obviously not seen the amount of tax we pay. If you knew, you would realise we have a tax problem not a cash problem” My reply is often yes but the profit it is not enough to support the demands the business has for cash flow.

We once had a client showing significant profits. I suggested that they needed to be careful with future developments they were planning. They were very annoyed. With a business heading towards more than $10 million turnover in a twelve – month cycle, they generated approximately $250,000 in cash surplus. This was leaving very little in reserve to cover negative cash flow impact for example for stock debtors or creditors, let alone any variances in margin or overhead costs. Another business we looked at was showing profits of $300,000 to $400,000 plus they required $700,000 to $800,000 to fund cash flow demands.

Cash flow demands that are often over looked are increases in stock, debt reduction strategy and expenditure funding lifestyle choices.

Regular demands on cash include but are not limited to the following:

  • Debt reduction
  • Decrease in creditors
  • Increase in debtors
  • Increase in stock
  • Purchase plant and equipment
  • Extra drawing for the business owners

Once you understand the requirements, you are then able to determine what you need to generate in profit. If, for example, you require access to $562,000 and you have depreciation or non-cash deductions at an average tax rate of 27.5% you will require a profit of $703,408 to be cash flow neutral.

In a business you generate cash flow from the following activity:

  • Profit
  • Sale of and Asset
  • Increase in Debt

The business manager/owner has the choice as to how to fund the business. What are the requirements , what is appropriate and what are the risk considerations?