How Increased Sales Equals Negative Cash-flow
Let’s assume that in your small business over a 90 day period you need approx $30,000 to maintain your operations by paying rent, wages and other costs until the income from sales is collected.
It takes you normally 30 days to get the order, 30 days to make it and invoice and then 30 days for collection, so your costs are about $10,000 a month.
But, let’s also add say another $5,000 in costs as our invoice had 30 day terms but was not paid for another 15 days.
So, in fact our total expenses for the period were $35,000.
In the table below you will note that sales have increased from $30,000 in the Month 1 to $60,000 in Month 3.
The cost to produce these sales (Cost of Goods Sold – COGS) remains constant at 36% of the revenue and these costs are paid within the month they are incurred.
The operating expenses for the business remain constant at $10,000 per month and the business collects it invoices 45 days after issue.
You will see in this example that your business produces its goods in Month 1, issues its invoice and collects it 45 days later which is sometime through Month 3.
This example shows that whilst the business has projected profits of:
Month One: $9,200
Month Two: $18,800
Month Three:$28,400
Your account would be overdrawn:
-$48,600 in Month Three
Without approx. $50,000 of working capital available, your business will start to experience problems in the first month of operation and may well be failing by Month 3.
If however if it can continue to operate through to Month 6, the profits made on each month’s sales will begin to flow into the bank account. This is why it’s extremely important to forecast not only a Profit and Loss for your business, but a Cash-flow report as well. This will tell you immediately how much working capital you need for the coming months.
| Month 1 | Month 2 | Month 3 | |
| Sales | $30,000.00 | $45,000.00 | $60,000.00 |
| Cost of Goods (36%) | -$10,800.00 | -$16,200.00 | -$21,600.00 |
| Expenses | -$10,000.00 | -$10,000.00 | -$10,000.00 |
| Total Cash Out | -$20,800.00 | -$26,200.00 | -$31,600.00 |
| Profit | $9,200.00 | $18,800.00 | $28,400.00 |
| Cash In | $0.00 | $0.00 | $30,000.00 |
| Cash Out | -$20,800.00 | -$26,200.00 | -$31,600.00 |
| Bank Balance | -$20,800.00 | -$47,000.00 | -$48,600.00 |
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