Some business owners believe if they are profitable they are on the road to riches. Unfortunately I have witnessed good profitable companies fail too often.

The majority of these failures are due to either not understanding how their business decisions have impacted their cashflows or alternatively how to effectively manage their cashflow cycle.

Firstly, profitable does not mean sustainable. Profit is an accounting term which illustrates revenue earned (mostly through sales) less costs associated with the sale and running the business. It does not take into account actually receiving the cash from these sales. Picture a company which sells $1 million worth of picture frames in a financial year and incurs costs of $500,000. This would result in a profit of $500,000 for the year.

What would happen however if during the financial year the company actually only received $400,000 from the sale of these picture frames due to slow or non-payment from customers? The company would have to find an additional $100,000 to meet its costs during the year. This may result in the company needing to call on past cash reserves, use of an overdraft or if neither of these is available-failing.

This is why cashflow management is integral to survival.

While the above scenario is more relevant to a trading business, cashflow management is just as  important for an over the counter business such as a pharmacy. There are several elements to understanding your cashflow (working capital) cycle. The three I will focus on are debtors, creditors and inventory management.

Debtors: This is concerned with the time it takes to for you to collect payment for the goods you have sold. Obviously the quicker you are able to get your money for your sales the quicker you can put that cash back to work to increase inventory and the like and further increase profitability.

As pharmacies receive payment at point of sale, it is extremely important to ensure this cash is effectively managed. Spending cash too quickly on items may result in not having sufficient cash to pay regular recurring fixed expenses. It is imperative budgets are prepared and cash set aside to cover these expenses. It is only then that excess cash should be reinvested into additional items.

Creditors: Inverse to Debtors, the longer the payment terms you are able to negotiate with suppliers, the more cash you will have to undertake other things or alternatively, the less cash you may need in your cashflow cycle. That is, you want debtors paying quickly but want to stretch out payment terms to your creditors.

The balancing act for trading businesses is to ensure you are not paying your creditors quicker than you are receiving cash from debtors. This will result in you effectively requiring more cash in your cashflow cycle; once again your cash is being tied up funding someone else’s business.

The challenge for point of sale pharmacies is ensuring enough cash is budgeted to meet the credit terms of suppliers and taking advantage of any trade discounts. As mentioned, the balancing act is to take advantage of these discounts while also ensuring you leave enough working capital/ cash in your cashflow cycle to meet all obligations.

Inventory: The largest impact on a pharmacies cashflow is inventory. Excess inventory can squeeze cashflow as inventory, until sold and paid for, ties up cash. It is also important to understand that cash tied up in inventory will take the longest to turn back into cash. Building up unsold inventory is like putting cash in a term deposit that you cannot use for other things.

If you have a cash crunch from any of the above three you will likely need to use an overdraft incurring interest, whereas if you have surplus cash by improving the three, you will have surplus cash that can be invested and create further wealth.

Understanding your requirements through a clear cashflow budget, coupled with inventory turnover ratios will help you plan for when you should be paying for fixed costs & creditors and how much inventory you should be ordering – assisting your business to not only survive but to thrive.

IMPORTANT INFORMATION AND DISCLAIMER
The information contained in this report is of a general nature and is not intended to be nor should it be considered as professional advice. You should not act on the basis of anything contained in this report without first obtaining specific professional advice. To the extent permitted by law, Bankwest, a division of Commonwealth Bank of Australia ABN 48 123 123 124 AFSL/Australian credit licence 234945, its related bodies corporate, employees and contractors accepts no liability or responsibility to any persons for any loss which may be incurred or suffered as a result of acting on or refraining from acting as a result of anything contained in this report.