Anika's goal for the year is to gain a deeper understanding of her business’s financial performance. Her first step is to get more comfortable with her financial statements — Anika noticed the fastenings switch from liability to asset and back again.
Anika books a working lunch with her mentor to find out why.
Because Anika pays in advance for a year’s worth of quarterly deliveries, the fastenings are a prepaid expense in the liabilities section of her balance sheet until the delivery arrives. Anika has paid for them, but can't yet make money from them.
Once the fastenings are in her workroom, they become a tangible asset on her balance sheet. Anika can now sew them into her dresses and send the finished garments to her stockists.
While talking about fastenings, her mentor suggests Anika thinks about her high cost of goods sold. Anika is determined to keep using New Zealand fabrics. But Anika’s keen to find a new type of fastening, as the Australian ones are expensive and about to go up in price.
Anika finds a supplier in India and has to weigh up the pros and cons of switching.
- Australian fastenings cost more but arrive within a week. With no delays in getting finished dresses into the shops, Anika recoups her costs quickly.
- Indian fastenings are cheaper but can take several months to arrive by container ship. Because Anika has to order in bulk and pay upfront, Anika’s out of pocket for longer.
This prepaid expense means Anika will have negative cash flow for much of the season. It will only improve once Anika sells all her dresses. See her figures in this sample cash flow statement: