The profitability pitfall – Why broke businesses may look healthier on paper

By Matt Storey, Partner

For most outside the business world, the profitability of a business is the hallmark of success.

Unfortunately, this view that looking good on paper with profitability equates to real spending power for a business is sometimes echoed by business owners.

SMEs are vulnerable to cash flow crises, so it is worth understanding why being profitable is not enough to make growth possible.

Healthy profits, unhealthy finances

It is worth noting that profit is a good thing for a business. The point is that profit is not a universal magic bullet, capable of solving all of a business’s challenges.

Profitability generally takes into account upcoming payments when determining the current value of a business.

This means that you may have sold goods or provided services that will effortlessly cover all outgoing expenses and leave you with enough money to throw the greatest Christmas party ever seen, but until that money materialises, you could still face challenges.

Long payment terms can erode business viability, especially if there are supplier costs involved with fulfilling the contract that will net the eventual payment.

Without addressing the short-term cash flow, businesses may be unable to pay suppliers and employees and may breach the terms of the contract to the point where no payment materialises.

Calculating cash flow

Leaving profit aside, businesses need to be mercenary with how they view cash flow.

It is important to weigh up the current funding for the month with the current obligations for the month and determine whether those obligations will be covered.

Some months will be more comfortable, especially once those larger payments hit the bank, but the tougher months must be endured to get there.

Financial forecasting is often the best way to calculate cash flow and learn of any shortcomings ahead of time.

Through this process, you can note whether the cash reserves you have will sufficiently meet your debts or whether alternative solutions are required.

There are plenty of ways to address short-term cash flow issues, such as through funding and grants, but these need to be used carefully to avoid impacting the long-term financial health of the business.

Having more awareness of your finances allows you to be more selective in how you address cash flow problems, giving you the opportunity to carefully select the finance options that work for you.

This is vital as different loans or investments will have different terms and choosing the wrong option serves only to push your problems slightly into the future.

Getting expert accountant support is essential if you want to make sure that your profitable business does not go under because you could not keep the lights on long enough to get paid.

Our expert team can review your current position and support you in addressing any cash flow challenges that are causing you stress.

If you have got your business to the point where it is profitable, that is a tremendous achievement.

Ongoing support ensures that your hard work is not in vain and improves the chances of long-term success.

For expert support in preventing cash flow problems in profitable businesses, get in touch with our team.