The Business Seems Profitable but Where is the Cash Going?

The Business Seems Profitable but Where is the Cash Going?

This is a common question by business owners who have good sales and their accountant has prepared financials saying they are profitable. The answer may lie in the balance sheet and the working capital cycle of the business.

The ways a business fund themselves does vary depending on the type of business it is. For a service business such as an accountant, they don’t have inventory as such, but do WIP (work in progress) that the business must fund before this work is billed out and payment received. They would also have accounts payable and accounts receivable.

For a pure retail type of business, they would have inventory and accounts payable, but generally not accounts receivable.

For some other businesses they may have inventory, accounts payable and accounts receivable.

Consequently, there can be a lot of cash tied up in this equation, and therefore, business owners should know how to calculate this.

The working capital cycle is purely the combination of all these factors.

For example a business may have the following scenario:

Debtor days
(How many days it takes to collect money from customers) = 45

Plus Inventory days
(The number of days the it holds stock ) =52

Minus Creditor days
(The number of days it takes to pay suppliers) =60

The sum of these is 37 days in this example, and this is what the business needs to fund in order to keep operating, by using internal or external funding. It is vital that the working capital percentage is less than the gross margin percentage. If not, more external funding is required for each new sale and the cash position deteriorates quicker.

There are various strategies on how to improve the working capital cycle. This should go hand in hand with looking at the performance of the whole business. A well-qualified experienced business advisor will be able to assist with this.

By |2019-01-25T08:56:07+00:00January 18th, 2019|Articles, News|0 Comments

Leave a Comment