Cash before profit: what traders and dealers can learn

Two ideas from Norm Brodsky and Bo Burlingham’s Street Smarts matter more to traders and dealers than to almost anyone: cash comes first, and a sale is not finished until you collect. (Both are explained on our Street Smarts ideas page.) Traders and dealers live on thin margins and on credit, both given and taken, so the gap between profit and cash can open up fast.

This article works through one made-up example to show how a distributor can grow, make more profit and still run short of money, and what to do about it. All the numbers are hypothetical.

Profit is not cash

Profit is what is left from your sales after costs, on paper. Cash is what is in the bank. The two differ because of three things a trader handles every day:

• Stock: you pay for goods before you sell them.
• Dues from customers (receivables): you sell on credit and get paid later.
• Credit from suppliers: you get goods now and pay later.

The money stuck in your business at any moment is roughly stock plus dues, minus what you owe suppliers. This is the cash cycle in rupees. Brodsky’s point that receivables are loans to your customers is easiest to see here: every rupee of dues is a rupee you have lent.

A distributor before growth

Ravi is an FMCG distributor (sub-level 1.3). He buys from the company and sells to retailers on credit.

Growth that eats cash

Ravi signs up new retailers in a nearby town. Sales rise by a third. But the new retailers are slower payers, and his average collection time stretches to 45 days.

Ravi’s profit nearly doubled, yet he needs almost ₹17 lakh more in the business. Unless he has it, or a bank lends it, he will be short of cash for more than a year and a half while his accounts show record profits. He may start paying the company late, which can cost him his distributorship.

This is what Brodsky means by putting cash first, and why he says a business should survive to viability (paying its own bills from its own cash) before chasing growth. Growth on credit has to be paid for in cash, up front.

What frees the cash

Brodsky’s answer for receivables is to manage them like a lender manages a loan book: check customers before giving credit, know how long each one actually takes to pay, and watch the ageing of your dues. For a trader, the two biggest levers are collection days and stock days.

The growth is the same and the profit is the same, but the cash problem shrinks from about a year and a half of profit to about four and a half months.

Practical steps that follow from the book’s advice, in Indian terms:

1. Check before you give credit. For a new retailer, start with a small credit limit and a short period. Raise both only after they have paid on time for a few months.
2. Age your dues every week. List what each customer owes, split into not yet due, up to 30 days overdue, 30 to 60, and over 60. Chase the oldest first.
3. Know each customer’s real paying days, not the days written on the invoice. A customer who always pays at 60 days on 30-day terms is borrowing from you for an extra month.
4. Collect in person where it works. Many traders collect on the delivery round; make collection part of the route plan, not an afterthought.
5. Be careful with big credit orders while you are small. One large unpaid bill can undo a year of work (see idea 7).

Dealers: the same problem, with interest

A dealer (sub-levels 2.1 to 2.3) usually pays the brand before the customer pays the dealer, and often carries stock on channel finance, a loan secured on the stock, with interest running every day the vehicle or product sits unsold.

For a dealer, “cash first” means three habits: order what sells, not what earns the biggest scheme payout (check the effective margin after interest); watch stock days by model every week, which makes a good weekly number; and collect from institutional and fleet customers as firmly as a distributor collects from retailers.

One balance-sheet check

Brodsky also suggests watching the current ratio: current assets (cash, stock, dues) divided by current liabilities (suppliers, short-term loans). In Ravi’s case, growth financed by a short-term loan pushes stock and dues up but pushes the loan up too. If the ratio heads towards or below 1, growth is running ahead of cash. Do this check every quarter with your accountant.

In short

• Profit is on paper; cash pays the bills. Track both.
• Growth on credit needs cash up front. Work out how much before you grow.
• Dues are loans. Check, limit, age and collect them.
• For dealers, stock costs interest every day it sits unsold.

Related: turnover and credit cycles, the stock and cash cycle, interest and dealer stock finance.

The ideas are Norm Brodsky and Bo Burlingham's, from Street Smarts and Brodsky's Inc. columns (sources listed on the ideas page). The explanation and the examples are ours.