In business, how much you keep and how much money is in the bank after covering costs matters more than anything. Turnover is vanity is about your ego, profit is sanity is about the reason you’re most likely in business, and cash is reality is what keeps the doors open.
Turnover is Vanity
Turnover is known by a few names: sales, revenue and even income. It’s the amount of money a business makes before subtracting any expenses.
The turnover is vanity part of the phrase is a particularly acute problem for many business owners. The focus is often on size. If you hear something like “I’m the CEO of a business turning over $25m” – then you know you’re witnessing emotion and ego in action. It’s the equivalent of an employee bragging about their salary. Business owner/operators also fall into this trap.
Let’s not kid ourselves. Turnover is important. If you’re only turning over $100K per year, then you don’t have enough to pay half a dozen full-time staff. You also need turnover to pay for other expenses like rent. If you’re only turning over $100K, then you’re probably self-employed and working from a home office. Many successful businesses start from humble beginnings, but such beginning are not usually the end goal.
However, a bigger turnover also means the potential for bigger losses, so beware! If your ego is in overdrive and you have a huge turnover but you’re running at a loss, you’ll be seriously stressed and your business won’t be far from going down the gurgler. Higher turnover businesses need better financial management as the risks are greater.
The good news is that huge profits will require reasonably high turnover levels. You can’t make $100K in profit from a business with $100K in turnover. A business always has expenses. If you can combine high turnover with profit, then you’re two thirds of the way there.
Profit is Sanity
Profit is the amount of money that a business makes after subtracting expenses from turnover. It’s the amount of money that you will see at the bottom of a Profit & Loss Statement – (also known as an Income Statement).
Most business owners are in business to make a profit. There are multiple other motives, such as independence, getting paid what you’re worth, being able to choose who you work with and which customers you serve, having the opportunity to excel and be challenged as well as making a difference. But ultimately, if you’re only bringing in enough to pay yourself and other basic business expenses, you’re just self-employed. To have a true business, you need something that produces profits and, ideally, can be sold.
Without profits you will never be able to invest in your business, which is necessary if you want to expand. That could be as simple as recruiting and training a new staff member. If your business can’t afford for you to work fewer billable hours or sell fewer widgets for a short period while you invest time in growing your business capacity, then you’re trapped in a cycle of self-employment. You also won’t have the money to purchase assets or make repayments for them. The moment you have debt, you need profit to service that debt.
To stay in business, it’s helpful if you know your break-even point. This is the turnover level that will cover your costs, making neither a profit nor a loss. It’s an important calculation for all business owners, and will help you know the minimum target you need to hit every month. If you run at a loss for too many months in a row, you may end up going beyond the point of no return. Getting a loan at this point will not fix your problems unless you have a plan to turn things around. It will only buy you time and give you the opportunity to dig an even bigger hole.
Profits are achievable. If you’re pricing your products and/or services correctly and you’re able to make sales that more than cover your expenses, then you’re on the right track. If you can bring in the money for the sales that you’ve made, then you’ve managed to cover the third key, and you’ll have a business that will last.
Cash is Reality
Cash is about cash flow. This is the money that flows into, and out of, your business bank accounts. Many things cause cash flow movements: the collection of sales, payment of expenses (including wages), payment of tax liabilities, repayments of debt, the acquisition or sale of assets and the inflow or outflow of borrowed funds.
Nothing will bring your ego down to earth faster than a cash flow crisis. There’s one word that defines this scenario better than any other: stress! When your bank account balance is hovering close to zero, you don’t have the money to pay employees or suppliers or meet other financial obligations. No cash equals no business.
If your business has a good turnover and makes decent profits, then you need to chase the money that you’re owed by customers to make sure that you have a healthy cash flow. To quote Alan Sugar, “Getting paid is the most important part of your business.”
You can borrow from the bank to finance the gap between paying expenses and receiving your revenue, but this is an expensive option and eats into your profits. Likewise with debtor factoring, which involves engaging another company to collect what’s owed to you. The debtor factoring company will usually give you a certain percentage of the invoice value whether your customer has paid yet or not.
Some less expensive options include running credit checks on your new customers, taking deposits, insisting on COD and offering multiple payment options (credit cards, BPAY, PayPal, direct debit, Stripe, eWay). You can also offer invoice discounting, which is offering something like a 1-2% discount if the customer pays by the due date. Also, make sure that you are invoicing promptly. You’re not helping the situation if you’re behind on your invoicing.
Pay your suppliers on time. They will be more helpful in difficult times if you have a good payment history. If you discuss the challenges that you are experiencing, negotiate alternative payment arrangements and stick to your word, you’ll find your suppliers to be a valuable ally.
Cash gives you options. In addition to being a critical component for a healthy business, having cash means that you can take up opportunities that are unavailable to someone without it. You might be able to purchase an asset that your business needs or buy discounted stock from a competitor that is going out of business. Or you might even be able to buy their entire business!
Think about providing awesome products and sensational service, but your ultimate objective is to make profits and have a healthy cash flow. If you achieve this, you will have a business that will stand the test of time.