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The Case of the Disappearing Profits
|
Sales |
$150,000 |
Cost of Sales |
(105,000) |
Gen. $ Admin exp. |
(30,000) |
Net Income |
$15,000 |
However, Dan Dapper (known as "Dandy" to his friends) was
not in a position to enjoy his success. While the company showed profits,
the big jump in sales lead to a $25,000 cash flow deficit. By the end
of January 2002, the company was out of cash.
Note:
What is more important - profits or cash flow? What Mr. Dapper forgot was that the income statement is an accrual statement - it records sales when they occur, not 30 days later, when the business collects the accounts receivable. In addition, expenses are accrued as incurred, although a company may pay those obligations later. Some expenses, such as depreciation and amortization of prepaid items, represent prior cash payments and this even adds more mystery (smoke) to the picture of cash flow - to creditors and the owner.
LIV-HI Inc., Cash Flow 1/1/01-1/31/01
Beginning Cash (in bank)
.......$10,000
Collections (Dec. sales)
.......100,000
Operating Expenses
.......(30,000)
Payments (December purchases)
.......105,000
Cash shortage
.......($25,000)
Conclusion: What appears to be a $15,000 profit for the month of January
is a $25,000 cash flow deficit. The $40,000 difference emphasizes the
difference between accrual and cash accounting.
Solving the Mystery: Dan Dapper could have filled the funds gap with external
financing, additional investment or accelerating collections of accounts receivable.
What is the Moral of the Story? Credit managers beware: look for the "hidden
card," the smoke, the mirrors: watch the flow of cash!
1 Paul Beretz, CICE (Certified International Credit Executive), is the founder
and Managing Director of Pacific Business Solutions, a consulting company which
specializes in providing strategic planning and cash flow solutions. Paul received
his BBA from the University of Notre Dame, an MBA from Golden Gate University
and the Executive Award from the Graduate School of Credit and Financial Management
at Stanford University. His e-mail is pberetz@pacbizsolutions.com
Reprinted by permission from Trade Vendor Quarterly
Blakeley & Blakeley
LLP Spring 02
Business Credit Articles |