David Brown: Cash Conundrum

Don’t confuse cash flow with profit

BY DAVID BROWN

Published in the September 2013 issue.

Have you found yourself in a situation where your CPA tells you you’ve made a profit … and you’re left wondering where all the cash has gone? It’s rarer to find the situation the other way around … no profit but plenty of cash! But it can happen, especially in a cash business like retail jewelry.

Many jewelers make the mistake of confusing cash flow with profit. One of the benefits of retail is that you normally get paid now and can defer the cost of paying expenses until the following months. Sadly, one of the disadvantages of retail is that you normally get paid now and can defer the cost of paying expenses until the following months.

It requires careful management because you’re not just talking about periodic expenses like tax, but your simple day-to-day costs of running the business and buying inventory.

Take a new store starting up. Let’s assume they can make $50,000 of sales the first month. The cost of buying those goods will be $25,000 (at keystone) and they may owe another $10,000 in additional costs. For a start things look great: In theory at the end of the first month they would have $50,000 sitting in the bank (let’s ignore wages, rent and other outgoings that may have been paid as they go). It can be tempting to rush out and spend it! But wait … next month has $35,000 of expenses to be paid, never mind putting something aside for tax and contingencies. It’s easy to see where it all can go wrong.

I often see this situation with many clients. They have a good business but cannot seem to get themselves out of the stress of constantly owing money because of high debt and an extravagant lifestyle. This is even more painful to watch than someone with no money living beyond their means because with a little control and responsibility from day one they could have had everything they wanted.

I recall one store owner, some 20 years ago, who was earning over $100,000 a year in income, a princely sum for those times, but he had one of the worst credit ratings in town. He lived a champagne lifestyle, with a new luxury car purchased every year … on finance. With a debt-free slate he could have enjoyed all of these privileges on that income, but because he wasn’t prepared to get properly established in the early days of his business, he dug himself a hole he was never able to climb out of.

So how do you reduce debt and make sure you are living within your means?

1 Ask yourself do I need that for the business right now? All business-related costs should be incurred to either reduce other expenses (e.g. spending money on software can often save you the wage bill of someone preparing things manually) or increase income (e.g. hiring a consultant can help you to implement strategies that will increase your sales by more than the cost of the consultant).

2 Control your personal expenditure. You don’t have to live like a monk, but your spending needs to be manageable.

3 Look to refinance. If you can consolidate unsecured debt and credit card bills onto a secured facility at lower interest then do so … but be careful! Often replacing credit card debt with secured loans can free up the credit card to spend and result in even more long-term pain! This approach should only be taken where discipline exists.

4 Think twice before incurring additional debt. Is it necessary? Is there an alternative?