I hear you saying its obvious, but to some (and I’m talking about the micro business owner) it isn’t. The are many times then I reassure a business owner things are going well and in the right direction to be asked ‘then where’s the money, cos it isn’t in the bank’.
I think of it simply as the money that’s tied up in the business, and sometimes the business has more tied up in it than other times. And growth increases the amount of money that’s tied up so be aware that a decition to grow your business will not in most cases result in an instant jump in the bank balance.
As soon as you stock up the money that was sat in your bank account is now sat on a shelf and will stay there untill it’s sold. You then have to wait the 30/60/90 days until it arrives back in the bank. Driving sales increases the debt book which is closer to the bank than stock but it’s still tied up in the business. So you stock up then sell it and then replenish stock that’s double whammy to the bank timing wise because you can be sure the supplier will want to be paid before the customer has and you have bought two lots. That’s why there’s no money in the bank.
This is why I tell clients that it’s all well and good looking at the P&L and cheering then crying into a bank statement, within your management information you need a balance sheet. This tells you what your bank account could look like and how close the money might be to arriving back, and of course how much of it is about to fly back out the door!
Growth is great, but needs controlling so as not to over stretch the business. Make sure the working capital ratio under review. The working capital ratio (Current Assets (stock and what you’re owed)/Current Liabilities (what you owe) indicates whether a company has enough in the short term to cover short term debt. Anything below 1 indicates negative working capital. While anything over 2 means that the company is cash rich (and could have capacity to use funds to grow). Most believe that a ratio between 1.2 and 2.0 is sufficient.