Wednesday, January 12, 2011
In the case of Shoes of Prey we're in the fortunate position that we receive payment from our customers first, then pay our suppliers after the shoes have been made and shipped. This is fantastic from a cash flow point of view. The situation gets even better in periods like the lead up to Christmas where we've sold hundreds of gift certificates. The gift certificates are paid for in advance then may not be redeemed until some months later.
It would be very tempting to see this money we have in the bank and go spend it on a fancy office or to experiment with a Shoes of Prey store, but while cash-flow is great, we need to keep in mind our profit and balance sheet. It's all well and good having cash in the bank, but when we look at our balance sheet we now have a liability equal to the cash we have in the bank for all the outstanding gift certificates we've sold. As those gift certificates are redeemed we'll be paying our suppliers without receiving additional payment from customers. The same goes for profit. Just because we've sold lots of gift certificates that are yet to be redeemed doesn't mean our profit margin has increased. If we just looked at our cash situation during December things look fantastic. But we need to remember that January and February will be quite different from a cash point of view, and despite the cash situation our profit margins haven't changed.
I may have thought those Management Accounting classes at university were an incredible waste of time, but those lecturers were actually on to something. :)
Posted by Michael Fox at 9:07 PM