This is an expanded version of an article which originally appeared in the January edition of INSTORE.

Independent jewelers enjoyed another strong sales period last month with our data showing same-store average sales on a rolling 12-month basis increasing by 1.05 percent from $1.54 million to $1.67 million between September and October. Annualized, that is equal to 12.6 percent growth. Year on year, the performance is even better with monthly sales rising from $91,272 in October 2013 to $106,557 in October 2014.

Healthy results indeed; yet if the average store is doing so well why does it feel like it’s not? Most jewelers complain about cash shortages even when profit reports are healthy. Where has all the money gone?

Let’s take the average store’s monthly sales figure of $106,557. A typical jewelry store is predominantly a cash business generating virtually 100 percent of its sales through card or cash purchases that are settled either immediately or within 24-48 hours. Yet most businesses need only to outlay staff wages (the average is around 16 percent) and rent (let’s assume 10 percent) within the month that cash is received.

Assuming the typical business makes a net profit of 15 percent, and we deduct 16 percent for wages and 10 percent for rent that has to go out immediately, that means 59 percent doesn’t go out until the accounts are paid the following month: a buffer of between 2-6 weeks depending on when sales happen. For the average business, this buffer would be around $60,000.

The buffer is in fact better than that – as the 85 percent (sales minus net profit) allowed for expenses includes depreciation, which is not a cash expense payable now (you may, however, want to set aside the amount of your depreciation each year into a replacement asset fund for when these assets need to be replaced).

The upshot is most businesses get to keep someone else’s money for a period of time before they have to hand it over. That inventory piece you sold may have a clause from the vendor saying it still belongs to them until the account is settled so effectively if you’ve sold the piece and not yet paid the vendor, you’re getting an interest-free loan until payment is due. To be sure, you might argue that you have already paid for a piece that you sold, and in fact you may have paid for it two years ago and it’s been sitting around ever since! Let’s not forget, however, you are getting other items in from vendors each month (reorders, new inventory, etc) for which you have a buffer period before you have to pay.

You may not notice this buffer, because every month money comes in and money goes out. The easiest way to understand this is to think of a business that starts from scratch. Jane opens her store and makes $50,000 in sales the first month. After deducting wages of $8,000 and rent of $6,000 she is left with surplus cash of $36,000. She has vendor accounts to be paid on the 20th of the following month of $30,000 – this amount is effectively an interest-free loan of 2-6 weeks from the time she sells her goods until the account has to be paid (note her initial inventory is not counted as it is part of her initial business investment). In addition, she should have a cash surplus left after paying the wages, rent and vendors of $6,000, which is effectively her profit – a total cash buffer of $36,000.

Now the good thing for Jane is that each month she will still be carrying forward an interest-free loan from her vendors plus whatever profit she chooses not to draw down for the business. It gets even better – with consignment product from vendors a lot of the product sitting in the store may not have been paid for, further enhancing the cash-flow benefit to the business.

Sounds good – so why doesn’t it equal reality?

There are two primary reasons why most business owners have cash-flow issues: they reinvest more in inventory than the business needs and they take more out in drawings than the business will allow them.

Parkinson’s Law states that work expands to fill the time available. There is a similar law around cash-flow: expenses expand to fill the money available. Most people spend what they make (sometimes more) – a wage-earner on $50,000 per annum will spend $50,000 (if they are undisciplined, the credit card will give them more than that). It’s easier for a wage earner to not overspend, however, as they get the same amount each week, and generally know what it will be. The danger for most store-owners is that they are under a false impression as to what they truly earn. Because cash arrives up front it’s easy to make the mistake of thinking it’s all profit to be spent how you like. In Jane’s case, she could have looked at her bank account at the end of the first month, seen $36,000 sitting in the bank, and gone on a spending spree accordingly, forgetting that her vendors still have to be paid.

This is the biggest danger of a cash-flow positive business and one that all jewelers need to be aware of. Always make sure you have a buffer; pay an amount into a separate account that you don’t touch before you make spending decisions. Your business will thank you for it.