TSH 27: The difference between sales, profit and cash

Reading time 2 minutes

Remember the time you had a record sales month and had to borrow money to run your business even though you thought you wouldn’t need to?

I do.

It’s part of the reason I quit wholesale and turned my focus to cash-positive ecommerce. 

I spent years working out what I was doing wrong. Here’s what I worked out:

The difference between sales, profit, and cash

It sort of sounds like a riddle, but these three things are quite different, and not knowing how to make each one work can spell disaster for your business. 

When I was starting out, I either thought I knew the difference, or I pretended I did, if the topic was ever raised. It’s important to get humble and start learning - It's ok to say “sorry, I don’t understand”, which is something I started doing, and still do. I never nod and agree for the sake of it.

So let’s get into it.

Gross sales is what Shopify spits out in your dashboard when you sell products to customers. Net sales is the same minus refunds. Some people take discounts off of gross sales to give you net sales, other people don’t factor discounts anywhere, it doesn’t really matter for this discussion.

For this article, sales is what hits your bank account, assuming you don’t have loan repayments coming out of your sales. Sales is what most businesses rely on for working capital, in other words how you pay for your business expenses and generally run the day to day.

Net profit, sometimes referred to as EBITDA (Earnings Before Interest Taxes Depreciation and Amortisation) is your net sales, less your cost of sales, less your operating expenses. It almost never matches what is in your bank account, so it’s not necessarily the money that you’re left with at the end of each month.

Cash is the money that’s in your bank account, usually recorded at the end of the month.

One of the reasons that you could be profitable but have no cash, is that you’re investing your cash into inventory, which is not recorded as an expense, until you sell it (hence the term cost of goods SOLD, not purchased). Stock is an asset, and is recorded as such until it's sold, where it converts to an expense, that brings your profit down. 

With that in mind, a common reason for profitable businesses to have low cash is that your purchases, combined with your cost of sales and operating expenses, exceed the money coming in. In other words you can be profitable and still have more money leaving your business than coming in.

As an added kick in the teeth, you may land a big tax bill on your profits, and not have the cash to pay for it - super common.

The reason for this issue is that you’re purchasing more stock than you should be. So your sales look good, your margin or COGS could look great, your profit nice and high, but to get your sales, you’re buying way too much stock - maybe your range is too big, and your sell through too low. You’re throwing so much stock at the wall to get your sales, that your purchases outweigh what you can afford. 

Remember my previous article, on working out how much stock to buy here. 

One simple rule

The simple rule I learnt was that your sales coming in, have to exceed your cash going out.

Easier said than done.

Once more - Your operating expenses PLUS your purchases, must be lower than your cash coming in. The difference between those numbers will be the cash you’re left with. You should aim to have enough cash in your business account, to run your business for 10-12 weeks without factoring any incoming sales. A good lesson was learned during Covid, when many businesses had no sales coming in, but still needed to pay rents, wages, and other costs. 

Tip

Pay your bills on time. Falling behind on bills will make it pretty hard to stick to my rules above. If you do need to wholesale cut off anyone who pays you late, and consider using the Shopify B2B portal, and taking cash up front instead of assuming you need to offer every business credit terms. 

So, where else did I go wrong?

I skipped the queue

I started when I was young, about 23, eventually turning a side hustle into a full time business at about 25. Check out the photo below I posted on Instagram of me taking my first trip to China, to visit shoe factories.

While it was admirable starting a business so young, I made the mistake of skipping valuable lessons - business basics like how to create a budget (and stick to it), teaching myself along the way.

To be fair, there weren't many resources available for me back then, but it bugged me so much that I ended up doing an MBA in my 30’s, and ever since I’ve kept signing up to programs, reading books, and being taught new business skills by people who excel in their field. It was also the driving factor for me to write Shopify for Dummies, and Selling Online for Dummies, resources which I felt would have helped me be a better business person at the time.

I kept over ordering stock

If you’ve followed me long enough, you’ll know I talk about this alot. It’s important to note that the advice I give is based on my own experience, not what I think might happen or work. I used to over order all the time. 

I remember on one occasion, I was sitting in a factory in Guangzhou, in southern China, talking to the owner of an amazing shoe factory. Their samples were incredible, just what I needed, I thought. Fast forward one hour and I’d been talked into leaving a US$15,000 deposit for a bunch of samples, which I would get back if I placed an order of at least 500 pairs of shoes per style.

I stupidly agreed, because I was allowed to do 100 per colour, meaning I had 5 colours per style, 100 of each colour. Crazy. All I did was take a large sum of money, and spread it across a very narrow range that offered way too many colour variations per style - a move which will usually result in heavy cannibalisation of sales. 

I learnt two lessons from this that you probably hear me always preaching about:

1. Inventory breadth over depth. The customer doesn’t care how many of each shoe I had, but they did care how wide my offering was. A wider choice increases the chance of a sale. Overkill on colour variants cannibalizes your product sales. Nobody needs 5 pairs of the same shoe - I would rather see 5 different shoes.
2. Don’t order more than you need to. If you can’t sell through the stock in 3 months, you’re ordering too much, and you will eventually run out of money.

Again, read my previous blog here on how much stock to order, if that sounds like you. 

I borrowed money to get keep me going instead of grow

I was making good sales, over $1m a year, but it was all wholesale, meaning often more than 50% of those sales were late in hitting my bank account as cash, some stores were taking 12 months to pay me, and others either never ended up paying, or went into administration.

Because my products were in major department stores and online stores across the world, sales were good, so stores kept reordering, or wanting to place larger orders for the next season. 

The problem was, often they hadn’t paid me for the previous range, as retail stores often want 30, 60 or even 90 day payment terms.

In order to place my next orders, with my suppliers who wanted a 30% deposit, I had to borrow money, and I’d keep doing that, telling myself that I would pay it back when my major clients paid me. Which I sometimes did, minus the hefty interest charges on the loan. The problem is, that cycle continues, because it’s fundamentally part of your business operation, and it’s not going to fix itself until you shock your business out of that routine. Which I did, by focusing on cash positive ecommerce businesses, where I was paid up front, and by working with smaller factories with lower minimum order quantities, so I could outlay less cash, and make my ROI faster. 

Tip

Remember, the formula for ROI isn’t just what you make, it’s also about how much you spend to make it. Which of those two metrics is easier to control?

I was too worried about sales

I was so worried about sales, because I needed to pay my suppliers. Because I had so much stock, I kept running discounts or promotions to bring in cash. I even opened 5 retail stores and hired outbound sales staff as a way to find more sales.

I decided enough was enough, as I was damaging my brand. I pulled back from wholesale, and reduced my purchasing, and closed my stores.

My sales declined significantly, but my bank account grew rapidly. 

This is where I first started to understand the relationship between cash and sales, and just how distant it can be. It’s also when I developed an appreciation for the obvious point that building cash, really means you’re collecting more money than you’re outlying, over and over again. 

If I ordered 50 pairs of shoes, and I sold them in one month, instead of two months, I stopped worrying about the “lost sales”, as I realised that I had made my maximum ROI in an even shorter period of time than I had planned for. 

If I ordered 200 pairs of shoes, and sold 50 in a month, I wouldn't even recover the money I spent on the 200 pairs after one month, let alone started to build cash.

Tip

Sales results give only one aspect of how a business is performing, and can mask serious problems. Sales numbers without context are useless. In other words, how much did you spend to get those sales, and at what margin?

Well, that’s it folks. Remember to focus on building cash, because you probably started this business to change your life right, and sales doesn’t do that, cash does. 

Until next week,

Paul

If you want to work with me, here's how:

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