Why e-commerce companies should concentrate more on cash flow than profitAdmin
Cash flow: (noun) the total amount of money being transferred into and out of a business, especially as affecting liquidity.
E-commerce businesses worry a lot about bringing in the profit, but forget the importance of good cash flow. You may have concluded a good sale and made more than you spent, but unless that money is in hand at the right time you technically don’t have a profit. Simply put, if your money circulation is stunted, stuck or steamed, you can’t expect it to lubricate the wheels of your business properly. How then will you run the business?
To drive home the point, let’s look at the bad things about profit (yes, you read right; from this perspective it has a disadvantageous facet). Because income statements don’t reflect your complete current standing.
- You need to use profit money to repay debt (excluding the interest on loans, this isn’t accounted for in the P&L).
- You pay for expensive equipment but the cost shows up for over the lifetime of the equipment even if you have paid for it.
- It shrinks after it’s been taxed.
- You cut cheques but they haven’t been encashed, so it doesn’t reflect in your income statement.
- On paper your accounts receivables have been received, but unless people pay you how are you going to pay your own bills?
- The value of your inventory carries on your income statement although to extract that value you need to first sell it.
Do you see how misinforming it can be?!
Profit vs. Cash Flow – what’s the difference?
It’s all in the timing. A profitable business may be unable to pay its bills, and a business that meets all its financial obligations may not be profitable. You may be profitable over a few months but are you profitable in a day or week? Were you able to run the operation of the business?
For instance, with cheques, technically, you need to account for this money as debited so that you don’t make transactions higher than the actual cash balance left over; however, your bank statement will not reflect this until the receiver encashes the cheque, which they may have chosen not to do immediately or even within the month since receiving it.
Cash flow management (aka managing day-to-day cash flows and not doing monthly tasks annually)
- Keeping Your Books Properly
Book-keeping well done means a tidy record of all your transactions, a track of invoices, due or late payments, and an understanding of where your money stands. If done properly, you can generate accurate business reports which in turn help you understand your cash flow and helps you make better financial decisions, and lubricates the entire accounting process till tax day.
- Don’t Be Chaotic:
Paper trails don’t belong in a dusty shoe-box above a dusty cabinet. And the latter can’t fit 7 years’ worth of filing (which are the records you must maintain). You need to have a proper system to track bills, invoices, cash flow, and other monetary obligations or you won’t have a clue where it all went when you need to start filing taxes.
- Monitor cash flow:
The most elementary necessity of doing accounts and doing them right is to understand how much money you had, how much you have and how much you will have. Daily cash reports are important to understand how much you can spend without running deeply into credit or debit each week. Additionally it gives you vital data on profit, loss and the possibility to expand.
- Extrapolate cash flows for the following week
Each week’s demands vary, so there is no fool-proof method of predicting a penny-for-penny cash flow. However, each week’s demands can’t vary so wildly that you can’t foresee to an extent the expenses you will incur. You know what your scene was this week; use that experience to plan and budget better for the following one.
- Do bank reconciliations every day.
- Prepare cash reports based on the daily bank reconciliations.
- Make decisions on everyday cheques based on those cash reports.
- Use cash flow spreadsheets for a quick visual understanding of where and when you money is going.
- Forecast expenses by making a list of things you have to pay for (use bank and credit card statements for thoroughness).
- Forecast revenue (this is easier for better established businesses but must be done by all). You will have an idea about guaranteed revenue (subscriptions, long-term contracts etc.). Use past data to help with projections, taking into consideration seasons and holidays.
- Fill in the expenses and revenue sources into a spreadsheet, keeping in mind the latter may take a few days to reflect in your bank account.
- Keep this live cash flow spreadsheet constantly updated and available and add a new week of projections in the last column.
Cash flow benefits
- Since you can predict shortfalls, you can come up with a contingency plan ahead of time – e.g. asking a receiver of a cheque not to cash it for a few days, collecting outstanding money owed to you, run a promotion to drive sales etc.
- When you know what to expect, even if it’s bad, you will be more prepared to deal with it, thereby alleviating a huge chunk of your stress.
- Since you have a fair idea of how much money you actually have, you know when you have to save it for a priority expenditure, how much you can stash away, and what you can put into the growth-development of the e-commerce company.
- Being more accurate than budgets, it bluntly shows you what you’re actually dealing with.
- Your cash flow management allows you to leverage the trust of banks, suppliers or vendors when you need back-up during tough times. When you show them you when and how can pay them back they will be happy to work with you and maintain the business relationship.
So make sure that good cash flow is a top priority with your e-commerce business!