Business coaches often discuss the importance of managing your Net Profit and whilst this is fundamental to the success of a business, understanding how your actions impact the Cash Flow of your business is sometimes even more important. Growth needs money so often, businesses that are apparently growing beautifully close their doors – the reason – poor cash flow management.


Cash Flow is a measure of the change in all your bank accounts over a period of time. The starting point is the NET PROFIT/(LOSS) that your business has made for the period that you are looking at. If this figure is negative – it doesn’t necessarily mean that you are in a disastrous position from which there is no recovery. The reason for this, is that your OPERATING COSTS might include significant ‘non-cash’ expenses like ‘DEPRECIATION’/’WEAR & TEAR’. These are costs that reflect the expensing of assets that your business has purchased in order to generate income but since the company owns these assets, this ‘expense’ is not in cash (payment might have been made upfront). Whilst in the long run, these costs must be covered, it might not be an insurmountable problem in the short term.

There are other examples of non-cash items but we will move on. Once you have removed the non-cash items, we need to understand the impact of our WORKING CAPITAL in the business. Working Capital is defined as the Capital (that is Cash and other Current Assets) as well as Current Liabilities (representing money your Suppliers have provided in the form of credit) invested in the company for its day-to-day operations. If your Trade Receivables/Debtors or your Inventory has gone UP – this NEGATIVELY affects your cash flow as you have invested and tied up ‘cash’ in these Current Assets and vice versa. Equally, if your Trade Payables/Creditors have gone UP – this POSITIVELY affects your cash flow as you are able to use these funds required to pay for the day-to-day operations and vice versa.

So in short – increases in non-cash Current Assets DECREASE ‘cash’ but increases in Current Liabilities INCREASE ‘cash’ and vice versa. By adding, or deducting the effects of working capital changes, you get the CASH GENERATED/(UTILISED) FROM OPERATIONS and available for Investment in the business. If this result is negative, the business will need access to credit or ultimately raise new funds to stay in business.

The above is best explained through an example. When a farmer lands a contract with a big retailer, they are delighted, as this will increase sales dramatically. The retailer explains what they need and the following occurs:

  1. The farmer gets a loan to cover the cost of all the new material plus cover additional operating costs they will incur till they can deliver & get paid;
  2. They buy all the Materials, fertilizers and equipment they now require and plant the crop – the effect of this is to INCREASE the Inventory component of working capital;
  3. Once the new crop is ready, it is harvested and delivered;
  4. The farmer invoices the retailer for the crop delivered (this switches the Inventory – which now decreases, to Trade Receivable/Debtors – this increase means there is no positive impact on the cash flow);
  5. Since the order was placed, the farmer has had no money coming in BUT all of their operating costs, together with the interest on the loan obtained needed to be paid. As a result, the farmer is under extreme cash flow pressure. To TRY and manage, the farmer has negotiated more time from their suppliers – increasing the Trade Payables/Creditors and therefore positively impacting on Cash Flow for the time being.
  6. When the retailer informs the farmer that they are changing their payment terms from 30-days and will now only pay 90-days after the invoice date, the farmer either needs to find additional (expensive) funding, try to ‘discount’ their invoice to the retailer (at costs that will generally exceed any profit) or go out of business, as the accumulation of ongoing payment commitments cannot be met.

In the example above, IF the farmer had included ALL the new costs associated with the order (including covering costs till payment was received) and had placed a reasonable markup on all of these costs, then the anticipated NET PROFIT would have been very attractive. The change in payment terms however means that although the additional interest costs on the loan would probably have been covered, the lack of cash flow means that unless the farmer can raise the funds to pay their dues, they might be forced to close the business – INSPITE of being profitable, due to their negative cash flow position.

This example hopefully illustrates that monitoring your Net Profit figure is important, you must also consider the Cash Flow position of the business as many profitable businesses have failed for this very reason.

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