Cash is like the oxygen for your body, without it you die.
There's a saying you be unprofitable 3 times but you can only run out of money once.
At Coffee Hit we had implemented Open Book Management and reduced overheads costs greatly for 2 years, the business was profitable around 14% net profit. But we had no cash. Where was all this profit id often ask? Then to just make matters worse HMRC would want me to make a 5 figure payout to them for the profit I made! But I couldn't see the profit in the bank!
We were living week to week, any big invoices would cause great stress and anxiety, VAT payments were dreaded and Corporation Tax was a nightmare.
I knew I wasn't managing cash, in fact, I sucked at it.
I then read a book called Profit First by Michael Michalowicz. I instantly recognised it's straight forward no nonsense approach to cash that I can understand and implement into my business.
This book has changed my life, both in a business sense but also personally. If cash is a real problem in your business then I really suggest you read this book.
As your business grows you add overheads. It's natural. Then if sales stall or fall then we find it hard to cut overhead, we feel like its a failure, and admission of failure. So we take on debt, overdrafts, bank loans, credit cards.
Mike explains that traditional accounting has the following formula: Sales - Costs = Profit. As you can see Profit is last, its what's left over. What is suggested in the book as we should see the formula as Sales - Profit = Costs.
A reasonable profit should be taken out of sales, then what's left over is what we can spend on Overheads.
Heres what we did based on the book.
We set up 7 bank accounts.
- Owners Pay
- Corp Tax
- OpEx (Operating Expenses/Overhead)
You need to calculate the revenue in your business for the last 12 months, then calculate what you paid suppliers in the same period and also VAT. What's left is called Real Revenue. Work out what you paid in profit (not pay/wages), what you paid yourself, what you set aside for tax (Corp or Income) and what you paid in Operating Expenses. Then we work as a % the above based on Real Revenue. We also work out the % of All Income we are spending on Goods and VAT.
So in the beginning, it might look like: