Page 96 - Finance for Non-Financial Managers

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Profit vs. Cash Flow
If your business is a retail store, you typically sell something
and get paid in cash. The result is an increase in sales and a cor-
responding increase in cash in the drawer. But if you’re a suppli-
er to that retailer—the wholesaler—you’ll typically wait anywhere
from 30 to 120 days or more to get paid, depending on the
industry and the time of year. You still record a sale when you
ship your merchandise, but you don’t receive payment at the
same time. You issue an invoice with the payment terms of the
sale, typically 30 days or longer. The retailer records the invoice
into accounts payable when the merchandise is received and
pays it weeks or months later, ideally in accordance with its
terms. In the interim, you must accept the fact that although you
have a sale and a resulting profit, you have no money to back it
up. You must plan, then, to have enough cash on hand or
instantly available to pay operating expenses between the time
you ship the merchandise and the time your customer pays the
invoice, often including the cost of the merchandise itself.
For companies that sell on credit, waiting for customers to
pay their bills is the largest single factor necessitating extra cash
availability.

Type 2. Transactions That Decrease Profits but Don’t Reduce
Cash Until Later
The other side of the coin is the situation that produces an
expense or profit reduction first and a cash disbursement later.
The most obvious example is accounts payable, liabilities that
you incur when you purchase consumable supplies and servic-
es on credit. The supplies and services are typically charged to
expense (profits) when purchased, although the supplier’s bill
might not be paid until the following month.
Let’s take our Wonder Widget example. The owners might
have gained some cash flow advantage from purchasing their
raw materials on credit, as most businesses do. In fact, given
the demand for their products, they might have even put some
of those raw materials into production before they had to pay
for them. If they did, they could potentially have shipped fin-