If my business is making a profit, where is the cash?
Often small business owners find themselves in the position of running a great business that appears to be profitable but there never seems to be any money in the bank. It’s an important situation to address. After all, a lack of adequate cash flow is one of the main causes of small business failure.
Here are three reasons potentially profitable businesses have little money in the bank. What is the solution?
1. Using business money for personal reasons
Many business owners use their business bank account as a personal bank account, withdrawing the money for personal expenses, directly from the business. If this is you, read on. Of course, you need to earn a living. The issue is that when money is drawn directly from the business for personal expenses, it makes it difficult to determine the business profits and how much you should be allocating yourself from those profits. It also makes bookkeeping and end of year accounting a lot more complicated and potentially expensive.
Instead of using the business account like a personal account, business owners should allocate themselves a wage based on previous years’ financials. Not only will this clean up the business books but as an owner you will see what is a reasonable amount to withdraw for that business. Wages should then be transferred from business account to a personal account at set intervals. If your personal money runs out, don’t go back to the business account for more money until the next withdrawal date. While this may seem harsh, remember that in setting up the wage amount you have calculated the amount your business can afford to pay you. Realistically it enables you to look at whether you are living within your means. With this information you can assess whether you need to look at improving business turnover, profit margins, productivity. Cleaner books and wages will give you a better indication of cashflow throughout the year and where improvements need to be made.
Regular use of the business account, even for relatively small amounts, adds up and can have a drastic effect on a business’s cash flow. If you need help determining an appropriate wage and how to set this up, give us a call.
2. Not collecting payments
Your business needs to make money. Why else would you be in business? To do so, your customers need to pay their bills. You have provided a product or service and you should be remunerated in a timely manner.
Not sending out invoices on time, not following up when customers fail to pay and not conducting adequate credit checks on customers will all put cash flow in jeopardy.
It’s best to send out invoices with clear payment terms and follow up immediately if customers fail to pay on time. If you don’t send out an invoice while the service is still fresh and positive in the customer’s mind, by the time they receive the late invoice, they are less motivated to pay the bill. You can also put procedures in place to avoid certain customer types who are unlikely to pay for work done. Put procedures in place to minimise potential losses from a client not paying, for example, require a reasonable deposit pre-job or for a product is ordered in for a customer. If your service is provided over a long period of time, look into partial regular payments. No one likes a giant lump sum bill at the end of a job. By reducing your risk you will also improve cash flow management and improve your customer profile.
3. Not preparing for tax season
Many small business owners see tax as something they can worry about later. The reality is tax is a never ending cycle that you need to keep on top of. We can estimate your tax bill for the upcoming year to help you plan for the tax bill at end of Financial Year. If your circumstances, profits or losses change in any way that might affect your tax, be sure to let us know so we can factor that in to your tax planning ahead of time.
The biggest issues can arise after a bumper year of profits and enthusiastic spending. Many business owners get caught up enjoying the jump in profits but forget that with this comes a jump in tax payable.
Treat your taxes as a regular expense. Set money aside each month to pay taxes. Either set up an account on the side or talk to us about the potential to set up of PAYG instalments (Pay As You GO) direct to the tax office. If there is a drastic increase in profits one year, be sure to set aside even more money. Being prepared is far better than being caught with too little. It can be rewarding to have a little cash leftover after EOFY or even sometimes a tax return at the end of the year if you pay too much through PAYG.
There are steps you can take to help ensure your business is profitable, with money in the bank. First, learn how to read and understand the balance sheet and debtors ledger. These show how much money is coming in and where it’s going. It also highlights which customers aren’t paying their bills.
Avoid using the business bank account for personal expenses. Instead, set a reasonable wage appropriate to the business profit. Limit personal expenses to that amount.
Finally, understand your business liabilities. Liabilities affect how much cash is available for the business. Even small liabilities add up quickly. Know how much is owed, how much is paid monthly and when those bills are due. Xero is a great way to keep on top of the. We can help set you up on Xero and teach you how to use it to its full potential.
By keeping track of the money coming in to the business and knowing where it goes in expenses, can help you ensure your business not only makes a profit but actually has money in the bank.
Got a question about your business? Let’s talk.