Business finances.

Why there is profit but no cash

The most common financial problem of a small company sounds exactly like this. Sales are coming in, the report shows a profit, but there is nothing to pay the supplier with.

The reason is that profit and cash in the bank are different things. Profit arises at the moment of the deal, cash at the moment of payment, and between the two there can be weeks of deferred payment, advances to suppliers and next period's taxes.

Hence the first rule: you need to look at at least two pictures - how much you have earned and how much cash you will have in a month. The first tells you whether the business works. The second tells you whether you will survive until that becomes apparent.

Accounting: what to record

Accounting is often put off because people picture it as bookkeeping. But management accounting is not reporting for the tax office; it is answers to the owner's questions, and it starts with the basics.

• Every inflow and outflow of cash, with a date and purpose. Without this, no further step is possible.
• Splitting costs into fixed and variable. The former do not depend on sales volume, the latter grow with it - and they behave differently in a crisis.
• Separating the company's money from the owner's personal money. Mixing them is the cause of half of all mistakes in assessing the state of affairs.
• Obligations: what you owe and what you are owed, with dates.
• Revenue by business line, not as a single total. Otherwise a profitable line quietly feeds a loss-making one.

At the start a spreadsheet is enough. Dedicated software is needed when there are so many transactions that the spreadsheet starts to lie - and not before.

The budget as a working tool

A budget is often drawn up once a year and never revisited. In that form it is useless: it is a forecast that went out of date a month later.

A working budget is built differently. It sets a frame for the main line items and is compared with actuals once a month. The value lies in the comparison itself: a discrepancy reveals either a planning error or a change in the business - and both are worth noticing in time.

It is better to plan from the money rather than from wishes. Count revenue on a conservative scenario and costs on a pessimistic one. If it adds up, you will have a cushion left. If it does not, you will find out on paper rather than in the bank account.

A separate line is the reserve. A cushion covering three months of fixed costs turns any setback from a catastrophe into a workable situation.

Metrics worth watching

There are dozens of financial metrics, but a small company needs only a few, provided it looks at them regularly.

Cash in the bank and the forecast for the coming weeks is the most important one. It answers the question of survival.

Margin by business line: how much is left after direct costs. This is where you discover the products that sell well and bring in nothing.

Break-even point: what sales volume covers fixed costs. Knowing it, it is easy to understand how close to the edge you are.

Customer acquisition cost and how much a customer brings in over the whole time they work with you. This pair of figures determines whether you can invest in advertising at all, and how much. How to calculate them is covered in our article on return on investment.

And accounts receivable - how much you are owed and for how long. This figure grows quietly while nobody is looking at it.

The marketing budget: how to stop arguing about it every month

Promotion spend is most often the first thing to be cut, because its effect is not as clearly visible as rent or salaries. The problem is solved not by arguing but by translating marketing into the same units as all other costs.

This takes three figures: what an enquiry costs, what share of enquiries turns into a deal and how much you earn per deal. From these you derive the acceptable cost per lead - the upper limit up to which advertising remains profitable.

From then on the decision is made by arithmetic, not by gut feeling: a channel that fits within the limit is funded; a channel that exceeds it is stopped. How to compare channels with each other is described in our article on choosing channels.

It is also useful to split the budget into two parts: what brings in leads now, and what works for the future - search, content, reputation. The second part looks like a cost and behaves like an investment: it lowers the cost of acquisition in six months to a year.

Investing in growth

It makes sense to direct part of the profit into growth rather than withdrawing all of it. The question is which part exactly, and into what.

Reserve first, growth second. Investing in expansion without a three-month cushion is a way to lose both the cushion and the investment.

Every investment should be described in the same way: how much it costs, how long it takes to pay back, and which figure will tell you it has worked. If there is no answer to the third question, it is not an investment but an expense.

And one overall metric around which decisions can be gathered helps you avoid spreading yourself thin - how to choose it is covered in a separate article.

Common mistakes

Counting revenue instead of profit. Growing turnover with a falling margin looks like success right up until the money runs out.

Making decisions on a single month. Seasonality and random fluctuations produce a picture from which no conclusions can be drawn; you need to look at three months in a row.

Funding a loss-making line from a profitable one without knowing it. Cured by splitting the accounts by business line.

Cutting costs blindly at the first sign of trouble. Cutting what brings in leads accelerates the fall in revenue - how to adjust sensibly is covered in our article on marketing in unstable times.

And the most common one - lack of regularity. Half an hour a month spent going through the numbers gives more than any accounting system nobody ever opens.

If you need your advertising budget to be a predictable line item with a clear return, that is advertising campaign setup. We start with analytics so that every investment can be matched against leads and deals.