Is it possible for a company to be profitable and still have cash problems?
|
A cash flow problem is when the cash going out of the business outweighs the cash coming in, causing a lack of liquidity meaning a company will struggle to make payments to suppliers, pay bills and ultimately running the business effectively. Show
Cash flow is often seen as one of the major financial indicators for the health of a business, because it impacts such a significant amount of the business. Success, in fact, is often predicated on good cash flow. However, it’s not always unprofitable businesses that can face troubles. If income is comfortably higher than outgoings, then surely there is cash in the bank? Unfortunately, this is often not the case. The main cause of this is of course late and non-paying customers. Cash flow is often a problem in small businesses, but it’s even harder to understand if your business is profitable. In fact, many profitable businesses will go out of business because they don’t have enough cash to fund the business. Profit does not equal cash: it is as simple as that! Profit is made after you have made sales and paid all expenses. Of course, you will have to pay tax on the profit as well. The remaining amount is then reinvested back into the business or distributed the owners. Cash is what the business needs to operate every day. Cash can come from different sources — profit is one — but you can also generate cash for the business by selling assets, contributing your own personal funds, using bank loans or seeking new investors.
Spend at the right timeThe key to remember is that we don’t spend profit in our business — we spend cash, and it is all in the timing. Firstly as the old saying goes, you have to spend money to make money. To make a profit, you first need to purchase goods or services to sell, so you will need cash before the sale is made. By selling your product or service at a higher price than what it cost, you make a profit. The point is you need the cash before you get the profit. The second timing problem — the one that catches most businesses — is providing credit to customers. The longer the customer takes to pay, the longer you have to wait for the cash, and in the meantime you have wages, rent, stock and other expenses to pay. This is where the trouble begins and often ends. Focus on what mattersYou need to focus on not only profit but also what drives your cashflow. If you have regular loan repayments, rent and other expenses that have to be made on time, then you will need enough cash to cover these while you wait for your customers to pay. Keeping track of your accounts receivable and following up on late payments will definitely help your cashflow. The other thing to remember is if you can get credit from your suppliers, this may mean that you don’t have to pay for stock until you have sold it — again making a big difference to your cash flow.
A business will need to be profitable to stay in business, so we also have to be weary of sacrificing profits to generate cash. Offering discounts to pay early will definitely help your cash position but will reduce your profit. To alleviate the conundrum of cash versus profit, it is best to make sure you have enough cash stashed to cover ongoing expenses. You may consider having a finance facility in place that will tide you over during a cash flow shortage, but this will cost in the form of fees and interest, which will reduce your profit. Cash flow and profit are two different financial parameters, both of which are important for running a successful business. Cash flow is how much money is going into and out of your business at a given time: the payments you are receiving and the payments you are making. Cash flow impacts how much money you actually have available at any given time. Profit is how much financial gain your company is making on its products or services. If you are bringing in more money than it costs to run your business, you are making a profit. Cash flow and profit are both important measures of success for a business and can affect how stable your company is. They also intersect with other important corporate issues, especially when your company grows rapidly. What Is Cash Flow and Why Is It Important?Cash flow is the money that flows in and out of the firm from operations, financing, and investing activities. It's the money you have available to meet current and near-term obligations. NoteCash flow is what allows you to pay your expenses on time, including suppliers, employees, rent, insurance, and other operational costs. Insufficient cash flow means that a business cannot meet its financial obligations, such as paying suppliers or even employees. This can happen even if you are making a profit on your products and services. In a growing business, a suddenly successful product can often create a cash flow crisis. What Is Profit and Why Is It Important?Profit, also called net income, is what remains from sales revenue after all the firm's expenses are subtracted. A business cannot survive unless it is profitable. NoteProfit means your business is making more money than it spends to stay in business. Sometimes, as with cash flow, the success of a product can raise expenses, which can impact your profit. Lowering expenses may allow you to make a profit, but this requires making effective cuts that don't compromise your ability to stay in business. How Cash Flow and Profit InteractBeing profitable does not mean you automatically have adequate cash flow. For example, if your product goes through a long sales chain and some of your wholesale customers don't pay on invoices for 120 days, you can make a profit on those products but still not have the cash available. If the suppliers of the material you need to make those products expect to be paid every 15 or 30 days, you won't have the cash you need to pay them and continue making products. Even though your unit sales are increasing and profitable, you won't get paid in time to pay your suppliers, meet payroll, and pay other operational expenses. If you're unable to meet your financial obligations in a timely way, your creditors may force you into bankruptcy at a period when sales are growing rapidly. Key Takeaways
Likewise, growing and having steady cash flow does not mean you are making a profit. For example, if you are worried about paying suppliers or purchasing new equipment, you might borrow money in order to meet expenses. This creates sufficient cash flow for your business. But if the debt that comes with paying that loan back raises your costs above the breakeven point, you are no longer making a profit. Rapid or unexpected growth can cause a crisis in either profit or cash flow. Many businesses, especially new ventures, struggle with either cash flow or profit at some point. However, if either cash flow or profit remains insufficient, eventually, your business will be unable to continue operating. How Rapid Growth Can Cause Business FailureRapid growth can cause a business to struggle with either cash flow or profit, and sometimes both. it can also create other struggles that impact both cash flow and profit.
In a growing company, keeping track of cash flow and profit also requires attending to these related issues. In some cases, it may be necessary to curtail growth or delay expanding in order to assure your business's financial stability and long-term success. Was this page helpful? Thanks for your feedback! Tell us why! Other SubmitSources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
|
