Generally, large companies are urged to pay their small business vendors as fast as possible. Have you ever realized that ‘getting paid on time’ is a problem facing most businesses in Singapore? Therefore, this article will discuss the nature of cash flow in a company especially as driven by the receivables.
Whenever you sell a service or a product, you create revenue. This is captured in your business records (Also see Why you can’t afford to be poor at Bookkeeping?) as either receipt of cash, or sold “on an account.” When a good or a service is sold “on an account,” it means that you have earned revenue, but you haven’t collected it – accounts receivable.
Well, most entrepreneurs understand the accounts receivable and can differentiate them from cash sales. However, there exist subtle differences in managing the accounts receivable and cash that most companies slip up upon.
Business is profitable only when they make sales that are higher than the costs. If your company does so, congratulations! However, you need to understand that cash flow and profitability are different things. A business can be very profitable but can be strangled by poor cash flow (Also see Accounting: Cash Flow Forecasting Mistakes to Avoid)!
Some entrepreneurs manage their businesses from the “bottom line.” Do you pay your business expenses from bottom line? Of course, no! You pay them from the cash flow. This is the reason I say managing your accounts receivables could save your business. Look at this example.
Assume that you run a lemonade business and daily sales are $120 and expenses stand $60. Also, assume that all expenses are in cash. This will give you a 50% profit, right?
Here is the difference between cash and accounts receivable: if you are selling your lemonade on cash, then, you will be making a positive cash flow of $60 (sales of $120 less expenses of $60). However, if you are selling your lemonade on credit, then you will make a negative cash flow of $60! (zero cash sales less expenses of $60). Therefore, a huge profit percentage on paper is meaningless if there is no positive cash flow.
Despite how simple this concept is, most businesses go wrong when it comes to interpreting the financial statements without assistance from professional accounting services. They will say that they are making huge profits yet, they are struggling to meet the daily expenses. Note that cash flow is very important business fuel and managing your accounts receivable wisely can help your business to have healthy cash flow.