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22 October 2020  -  Accounting Business

Is Business Turnover Just Vanity?

We often see businesses pursuing turnover on the basis that the more business that they do the “better” their performance will be, or at least appear to be.

Very little consideration is often given as to whether the increase in turnover is worthwhile and how this increase is achieved; did you have to reduce the sale price, increase costs, or have you considered what impact the changes will have on your net profit.  It would not be unusual to see a business with increased turnover but reduced profit. Even in the accountancy world we see firms with ever increasing turnover and ever decreasing profit.

What does that mean?

To explain, if you are currently selling 10,000 units with a £5 margin but could increase sales to 15,000 by reducing margin to £3, then your gross profit has fallen from £50,000 to £45,000.  You may have increased your sales by 50% but this has damaged your profit!  And profit is good!

This is why we would always look at profit and cash together.

Let’s say that you sold services of £100,000 which cost you £75,000 to provide, a nice straightforward profit of £25,000.

However, you won’t be paid the £100,000 for 30 days.  You need to pay out the £75,000 cost immediately – you now have a cash shortfall of £75,000 even though you have made a profit of £25,000, a situation that many will be all too familiar with.

What happens if sales keep growing?

If your sales continue to grow each month, then it is possible that your cash flow continues to get worse – and without visibility of this it’s very hard to understand how to plug the hole or even where the hole is! (why do I now have images of trying to find a puncture in a bike tyre in my head?)

To fix this problem (the cashflow problem, not the bike tyre), you need to make sure that you have reserves, either cash or the ability to draw on some sort of facility to pay the bills …

Alternatively, you could always try to negotiate quicker payment from your customers and / or later payment to your suppliers but never lose sight of the need for cash.

A cashflow forecast will help you focus on your numbers today, helping you stave off these issues and have visibility of what is ahead for your business.

So is it vanity?

In the short term cash is always more important than turnover.  You will always need the ability to pay your bills as they fall due because that’s the reality of day-to-day trading.