PROFIT IS VANITY, CASH IS SANITY AND OTHER CATCHY PHRASES!
“Profit is vanity, cash is sanity” or “cash is king”, they both boil down to the same thing without cash businesses will collapse and fail. There have been some big household name businesses that have failed in recent years due to a lack of cash and it often comes as a massive shock to the public. But without cash a business cannot operate, to all outward appearances they might appear to be successful and profitable, but profit isn’t the same as cash.
So, where might the cash be going? Well on “things” for starters such as assets within the business (tools, equipment, desks, chairs, IT equipment etc), stock, rent deposits, etc. It also gets “locked” within the business and this means that unless you are selling to the general public when the cash is with you within 2-3 days (card machine companies don’t pay it over instantly!) it can take 14, 30, 60, 90 days to get paid - it will depend on the terms offered but also on how long customers actually take to pay.
Businesses will also owe money – they need to pay suppliers, staff etc.
Let’s play with numbers:
Company A has sales of £50k and at the moment this gives £5k of bottom line profit – 10%.
They hold £10k of stock and their customers owe them £10k as well.
At the moment times are tight and they don’t actually have any cash in the bank.
Now turnover doubles:
So sales are £100k and 10% margin will give £10k bottom line. This means you would expect them to have £5k in the bank if the rest was the same wouldn’t you? (£5k of profit gave nothing in the bank, so £10k of profit is £5k more .. so £5k in the bank). But that increase in business means they needed to increase the stock that they hold, it’s now £20k and they’ve been so busy that customers are taking advantage of not being chased and now they are owed £25k. That’s an extra £15k tied up (oops) they haven’t made an extra £15k which means they are going to be facing problems if they don’t do something and fast.
So, cash is what keeps a business alive and keeping a close eye on it is essentially – growth needs to be controlled and managed. Profit is nice (obviously) but without cash there is no sustainable business.