Managing a small business's cash flow, profit is not liquidity
A small workshop buys materials for 30,000 in cash and sells the output to retailers for 40,000. A 10,000 profit on paper. But the retailers pay in four instalments, 10,000 every ten days. When the first payment arrives the owner wants to buy the next 30,000 of materials, and finds 10,000 in the till. The workshop is profitable and stopped. That's cash flow, and it has closed more businesses than losses ever did.
What you'll have at the end
An understanding of the difference between profit and liquidity, one book for every inflow and outflow, an account separate from the household's, and a payment schedule that shows you the gap before you fall into it.
Step one: separate business money from household money from day one
An account, wallet or envelope in the business's name, that only takes what belongs to it and only pays out to the household as your own salary on a fixed day. Whoever mixes the two never knows whether the business makes money, and discovers a year later that they'd been funding the household from capital. Your salary from the business is a fixed agreed figure, however small, and whatever's above it stays in the business.
Step two: record every pound, in or out
Small businesses that run "on blessing", money in and money out and nobody writing it down, never know their real profit or which line is draining them. A notebook, a file, a simple accounting program, or an accountant who comes once a month if it grows. The same rule you learned in lesson 2.1 for your home: record at the moment, read the month at its end. What shows up in the first reading surprises every owner: a small recurring line eating the profit.
Step three: draw the cash cycle on a sheet
Two lines: when money goes out, and when it comes in. Materials go out in cash on day one, production takes ten days, retailers pay over forty. The gap between the two lines is the amount you need sitting in the till to keep working without stopping, and it's working capital, a third thing beside profit and loss. Whoever worked it out before starting knew how much they really needed; whoever didn't is the owner of the stopped workshop.
Step four: close the gap from both ends
Shorten collection: a retailer paying half up front and half on delivery beats four instalments. Lengthen payment: a supplier who accepts payment two weeks later at the same price beats cash on the day. And a small discount for whoever pays immediately is cheaper than a halted production run. The gap that remains after all that is covered from the working capital you kept, never from household savings and never from an instalment plan.
Step five: pay people what they're owed, on time
An employee whose pay is docked unfairly sells less, grows careless, and leaves, and you lose many times what you saved. Workers' wages go out in full and on time as the first thing paid from receipts, before your own salary. And if you're not good at managing, there's no shame in hiring someone who is and staying the owner; most people who fund new companies demand a capable manager before they demand an idea.
Where most people trip
In month four, when the first good month arrives and its whole profit is drawn into the household. Month five brings a large order with no cash for it. First-year profit goes back into working capital until it covers a full cycle, as we said in lesson 1.4, and only then gets distributed.
Tonight's exercise
Open an account or envelope in the business's name. Draw the cash cycle: the date each expense goes out and the date each payment comes in for one typical order. Work out the gap in money. That's the working capital you need.
Questions I get asked
My business is tiny, I sell from home.
Same rules at a smaller scale: an envelope in the business's name, every sale and every materials purchase recorded, and a small salary for you on a fixed day. A business that starts organised grows organised.
A big retailer wants to buy my whole output on long payment terms.
Work out the gap first. A large order on long terms has killed workshops; if the gap is bigger than your working capital, ask for a deposit or shrink the order.
Should I take a partner instead of waiting?
A partner with money, a clear role and a written contract shortens the road, and sharing profit and loss is the root of honest trade. A partner with no role and no contract is the first problem of year two.
Log the business's inflows and outflows in Fawatery in an account separate from the household's, and each month you see its real profit and its liquidity without mixing the two
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Based on: "Catastrophic mistakes that kill your small business" from Al-Mukhbir Al-Iqtisadi.
The next lesson is about the cheapest business you can test today: an online store on a small budget, and what makes it live or close.