Profit on Paper, Nothing in the Bank
Lerato sews school uniforms. In the peak month she invoiced $6,000 of sales and her expenses (fabric, thread, wages, rent) came to $4,300. Yet her bank balance fell from $550 to $150. Two schools pay 60 days after delivery. Her fabric supplier used to give 30 days' credit but now wants cash on delivery. Last month she paid $900 cash for a second sewing machine, took $350 in drawings and still owes her assistant $600 in wages. Her records are a shoebox of receipts and two exercise books with some days missing.
1. Explain, using the figures, how Lerato can have made a profit and still have a cash problem. Then prepare next month's cash budget from: opening balance $150, expected receipts $2,200, fabric $2,800, wages $600, rent $400, machine instalment $300, drawings $350.
Read the worked answer
Why profit and cash differ.
- Profit = $6,000 − $4,300 = $1,700. But profit counts sales when they are invoiced, not when they are paid.
- Debtors. With 60-day terms, up to two months of sales may still be owed to her - possibly $8,000 or more sitting with the schools.
- The machine ($900) is buying an asset, not an expense, so it does not reduce profit but it does empty the bank.
- Drawings ($350) are the owner taking money out - again not an expense, but real cash gone.
- Unpaid wages ($600) reduce profit but have not yet left the bank, so next month's cash is worse than next month's profit.
Cash budget
| Item | Amount |
|---|---|
| Opening balance | +$150 |
| Receipts | +$2,200 |
| Available | $2,350 |
| Fabric | −$2,800 |
| Wages | −$600 |
| Rent | −$400 |
| Machine instalment | −$300 |
| Drawings | −$350 |
| Total payments | −$4,450 |
| Closing balance | −$2,100 |
She is $2,100 short - and that assumes every expected debtor pays on time. A profitable business can still fail on timing, which is exactly what her shoebox records are hiding.
2. List four actions Lerato could take in the next two weeks to close the $2,100 gap, ranked by how quickly each one works.
Read the worked answer
Fastest - under her own control (days):
- Cut drawings from $350 to $100. Saves $250 immediately. Painful, but the business cannot fund the owner and a machine at once.
- Delay the machine instalment by one month after speaking to the supplier. Saves $300 now, though it must be paid later.
Fast - one to two weeks: 3. Ask the fabric supplier for two deliveries of $1,400 instead of one $2,800 order, paid cash on each. This halves the immediate outflow and matches spending to receipts, while keeping the supplier's cash terms intact. 4. Phone both schools and request part-payment against invoices already delivered, offering a small discount for early settlement. This is the largest single sum and the only action that brings new money in, so it deserves the first phone call even though it depends on others.
Slower - for future months: 5. Introduce a 40% deposit on every new uniform order. She is currently lending customers her working capital for free.
Last resort: a short-term loan or overdraft. It closes the gap but adds a fixed monthly payment, so it must not become the routine answer to a planning problem.
3. Which three records should Lerato keep from now on, and which specific problem would each one have warned her about earlier?
Read the worked answer
1. A cash book (or simple cash flow forecast). Every receipt and payment dated, with a projected balance for the next two months. This is the record that would have shown the −$2,100 month before she ordered fabric and bought the machine. Forecasting is what turns a record into a decision.
2. A sales and debtors book. Each invoice: customer, date delivered, amount, date due, date paid. This would have shown her exactly how much the two schools owe and how much of her money is tied up in 60-day terms - the single largest cause of her cash gap. It also gives her the evidence she needs when she asks for part-payment.
3. A drawings and asset register. A one-line record every time she takes money out, plus a list of equipment (two machines, what each cost, when bought). This would have flagged that $350 of drawings plus $900 of equipment is $1,250 leaving the business in one month - money that profit alone cannot replace.
A stock book for fabric would be a useful fourth, since fabric is her biggest cost. But these three are the minimum: records are only worth keeping if they are read before a decision, not after.