As discussed in our last article, we believe that summer is usually a great time to spend a few days looking strategically at your business. We've noticed that a review of a few fundamental concepts has been a turning point for more than a few. So we're dedicating the month of August to this subject, focusing on selected fundamentals in this column.

In part I of this focus on money, we talked about the four factors that govern this subject: Income, Profit, Cash Flow and Equity. For this article we want to distinguish between profit and cash flow. While profit is what drives people to form businesses - profit by itself doesn't guarantee success.

What's the Difference between Cash Flow and Profits?

Profits are a measurement of the "value" that flows through your business operation. This figure can be very different than the actual cash that flows through the business in the same month.

The profit and loss statement, which is the principal tool used to measure the "value", can include some items that do not involve the exchange of cash. For example, depreciation (the way we record the reduction of loss of value for certain items like equipment, vehicles, and furniture) affects profitability. But depreciation does not affect cash.

On the other hand, most businesses need to borrow money to get started or to assist with growth. When you borrow money, the loan doesn't show up as income and the principal amount of the repayment does not show up as an expense (although the interest portion is typically booked to interest expense). For the most part, then, a loan doesn't affect the profitability of the business, but loans have a big impact on cash flow.

Cash Management Has a Time Element. This is something that takes many business owners (and individuals when we talk with them about cash management) by surprise. Service businesses are most affected due to a need for accrual-based accounting.

For example, Service Business A shows a profit of $20,000 for the month, based on time spent on jobs during the month, including two new jobs started at the beginning of the month. The business owner is elated. Invoices are sent out 15 days into the next month. Monthly payroll arrives 2 weeks later and the business owner struggles to meet the payroll as well as the other monthly financial commitments. He is looking forward to seeing the effects of that profit show up in the bank account!

But, 60 days later when the business owner reviews the accounts receivable report, he is astonished to learn that the two new jobs started now 105 days ago, paid their first invoices 75 days after the businesses' crew started accruing time for the job (and the invoices were paid on time!). The business owner is clearly frustrated, "why am I constantly struggling to pay staff and overhead when my books show a profit?" Because Mr. Business Owner, the combination of your billing policy, terms and procedures has you acting like a bank, except you aren't earning any interest on the credit you are extending. You started your crew/staff on a job that your customer won't be invoiced for until 45 days after you started work. Then you allowed 30 days for payment of the invoice - so the earliest you can really expect to see cash in the bank for work carried out on this single job is 75 days after you start work.

There are a number of ways that policies and procedures can be shifted to alleviate this problem, but the point of this article is to remind that when customers buy on credit, the revenue happens immediately (showing up on the P&L statement), but the cash comes in later, sometimes, as in our example, much later.

If you're well versed in the details of cash management then make sure you allocate time to look at your current cash management procedures to determine if you can make any adjustments to increase efficiency. If you're not familiar with this, then take time to understand it and work with your bookkeeper or accountant (or business coach) accordingly.

Just as in personal finance, the lack of good cash management has hampered the success of many otherwise successful businesses.

Asgill Post Ltd. provides assistance with Business Valuation, Financial Strategy and the Purchase and Sale of Companies. For comments or queries, contact Kumi Bradshaw MBA, CBA, BVAL via email at kumi@asgillpost.com or phone at 295-3301

Patterson Partners Ltd. provides cross-border tax, estate and investment planning services to dual citizens of the USA and Bermuda, their families and businesses. For more information, visit www.patterson-partners.com or contact Jennifer A. Patterson, CFP®(US), CIMA®, TEP via email at info@patterson-partners.com or phone 296-3528.