Over the years I have provided clients with numerous sets of financial statements, often depicting a good result for the trading year, summarising a well-planned tax position. However, a question that often comes to the table is, “why is there a profit but no cash?”

Understanding pricing points and margin control are important to ensure profitability, as is overhead control. However, that is all performance related. Whilst there may be a cash surplus it doesn’t appear in the bank account. Why? There can be a number of reasons, including:

1. Poor Debtor Collection: A sale is recognised upon the recording of an invoice or debtor. If there are not the appropriate debtor controls that sale will not convert to cash in a timely fashion. This is probably the most obvious and common reason.

2. Over Investment in Stock: If too much stock is being carried, whilst there may be a cash surplus from operations, what would have otherwise been in the bank account will be sitting in stock at cost. At present we are seeing an unusual circumstance due to supply issues, and clients are investing in material in advance. Whilst that is understandable, careful cash planning is required depending upon raw material delivery timelines.

3. Aggressive Debt Reduction: Paying debt down quickly is admirable. However, that should be balanced and understood in the context of cash surplus from operations. The good intention may be placing pressure on the business, particularly if there is a seasonal pattern for turnover.

4. Unplanned or Unnecessary CAPEX: After the earthquakes in Canterbury it was common to see new utes driving around. Not long after many were being collected. Most likely because although turnover was up, there was no understanding of the company’s cash position to plan for capital expenditure.

5. Excessive Drawing: It is important to understand the cash position alongside trading to resolve drawings in excess of remuneration that will not put the business under cash pressure.

A good standard cash flow statement, illustrating cash from operations, financing and investment activities is very useful to gain an understanding of cash flow. There are generic reports from some systems, however, in my opinion unless cash movement is defined between these three areas it can be difficult to easily decipher whether cash problems are performance or balance sheet related.

In summary, and in my opinion, by not preparing a periodic analysis of cash flow you are running the risk of poor decision making for the Balance Sheet or indeed missing opportunities for investment or dividend policy.