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Never run out of cash in your business! Use these three easy tools to keep cash flowing

by , 22 July 2013
After a really good month of sales, Mike, a business owner of a small chocolate factory, expects his bank account to show a large positive bank balance. When he checks, he sees his bank account is overdrawn.

Mike has no cash. The business is now in danger and he doesn't have the funds to pay staff.

He asks his bookkeeper Steven to find out where the money went. Steven had a look, and found all his cash was actually invested in his large chocolate inventory. It seems Mike liked to keep a lot of chocolate in the warehouse, in case his clients ordered more. If Mike knew these three easy tools, he'd still be in business.

Have you ever been in Mike's position? We'll show you these tools to keep your cashflow healthy.

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How to keep cashflow healthy

To keep cashflow healthy, you need to understand these two concepts:

  • Your own business's risk; and
  • Your businesses profitability.
That's great, but how do you do this?

To do this you'll use your Statement of Comprehensive Income (income statement) and Statement of Financial Provision (balance sheet).

But remember, these documents can only tell you about what has already happened in your business.

They can't tell you what opportunities or dangers exist in the market place. You'll have to keep a keen eye on your market environment.
We'll show you how to keep cash where it belongs… In your bank account! Keep reading to find out…

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This is how to keep cash in your bank account

Steve could see that Mike over-invested in inventory. But how did he see this so easily? He used these three tools:

1. Profitability analysis shows you how profitable your business is. For Steve, this showed him the difference between income and expenses. One important measure of profitability is net chocolate factory income.

2. Return on investment analysis shows you how well your investment is doing compared to costs. Steve knew that Mike was in trouble, because his cash was tied up in stock. He had costs linked to this, like warehousing, insurance and airconditioning. The 'cost of capital' for this investment was totally off. Mike could've paid salaries and bought raw materials instead of carrying all this stock. Plus, the stock's at risk of going stale.

3. Risk analysis shows you the threats to your business and how exposed you are to them. For Mike, the threat was obvious. He was exposed without any cash. Because he over invested in stock, he had no flexibility to pay for the other business overheads.
With these three tools, you will never land up in Mikes position. You'll see the warning signs long before they hit your pocket.

Want to know how to use these tools? So you can spot the red flags in your financial statements? Check out chapter F01: Financial Statement Analysis in your Practical Accountancy Loose Leaf.

Click here to order your copy.

Philip Rosenberg

Managing Editor, Practical Accountancy Loose Leaf Service

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