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Profit or Cash Flow 2
The previous article showed the difference between profit and cash flow. Most business people understand the difference, but my previous article highlighted the importance of cash management! I will try to go into more detail about cash management in this latest offering.
The thrust of my articles is to try to explain the difference between profit and cash. The cash raising strategy described below will reflect differently in the books of accounts of the business. In fact, these reserves will not be reflected on the profit and loss/income statement accounts and yet, it is the most important aspect of finance!
People are always tempted to spend more money than they earn. We see the constant striving to earn more from working and professional people. But after that increase in income, people are more indebted than before. Expenses chase income and often win the race. We remain trapped in the illusion that more money is the only way out of this mess.
Look at families taking on extra jobs, employees getting promotions with pay raises, businesses getting extra contracts but are short on cash or have more debt. When people earn more, they spend more. Simple as that. The strategy is to save money before it is spent. The excuse that there is no money to save is not valid. The sooner it is implemented the better. Discipline and dedication are required. It can work.
Bank Savings Accounts:
Open three different accounts in three different banks, in three different areas. The reason? The temptation to withdraw money from these accounts is limited. The account type doesn’t matter (preferably interest bearing), but designate as described in the previous article.
1. Building/Extension Fund
2. Tax funds
Commit to saving by signing a monthly transfer of say;
1. Building Fund @ 2% average monthly cash deposits
2. Tax funds @ 1% of average monthly deposits
3. Emergency fund @ 1% of average monthly deposits
Let it run for three months and gradually increase the percentage by 0.5% every month.
Treat savings as an extra expense and include the savings in your monthly budget.
Credit cards are controversial and problematic, but you can make this device work for you and your business instead of the other way around.
Don’t destroy your card, but keep it out of reach. If the repayment on the card is $500.00, commit yourself to paying an additional $250.00 on the card. Don’t make any arrangements with the bank, just pay the card directly. There are no bank charges on cash deposits made to credit cards.
What happens is, the bank withdraws their arranged amount and it is increased by additional payments, resulting in a rapid reduction of the debt on the card over a period of six months.
After twelve months, the credit card can change to a positive balance. Interest on cards with a positive balance can vary, but is higher than some savings accounts.
If you commit to the savings program described above, your savings accounts and credit card percentage and transfer arrangements, you will see a significant increase in cash flow and reduction in expenses. You’re not forced to save more, and can spend the available cash as you wish if all your bills are paid.
If the reserve amount increases, you can use it as follows, (preferably after twelve months)
1. Tax fund, to cover any unexpected tax
2. Emergency fund, any expenses not covered by normal insurance, employee incentives. holiday
3. Building funds, must be accessed after two years, but can be used to purchase capital equipment.
Use a credit card to purchase additional equipment when needed. And start paying off your card balance as soon as possible. Be careful, don’t go on a spending spree. Remove the card as soon as you use it for an emergency fund, don’t keep it in your wallet.
Create a separate spreadsheet for your accounting for cash in, reserve, cash out. Don’t use traditional accounting software (it will only confuse the process). Keep statistics on a monthly basis and start predicting your cash flow.
Don’t wait until sales improve, start saving now, even if it’s just 1% cash. See the savings after one year. Maybe three years later you can go on that dream vacation!
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