Cash flow management: How can businesses be profitable but broke?
By Emma Wilson, FMAAT, FCCA, ACA, BFP
A business can be both profitable and broke. This might sound like a paradox, as a business making money can’t have none of it, right?
The logic may not seem to follow, but there are instances where SMEs can be simultaneously profitable and without the liquid funds to pay bills or meet obligations.
As SMEs often have tight margins, making them more exposed to cash flow crises, we encourage business owners to reach out to an accountant for expert planning.
Why do healthy profits not equal healthy finances?
While profit can be a great measure to see if a business model is functioning as intended, it is not a complete picture.
For example, a company called John Doe Distribution invoiced £30,000 for a project on standard 30-day payment terms.
Looking solely through the lens of profit, this company has just landed a contract that will eventually lead to a £30,000 payday.
However, John Doe Distribution still must cover payroll, rent and project delivery costs that are due in the interim, before the money touches the account.
If this problem is scaled up and applied to several different clients that pay towards the end of their 30-day payment terms, or later than agreed, John Doe Distribution can find itself struggling despite healthy projects.
At worst, it could be on the brink of insolvency.
Why is cash flow king?
This is why cash flow is so important.
Cash flow focuses on the flow of money in and out of the business bank account to evaluate whether there is enough liquidity to cover wages, supplier costs and tax liabilities.
If obligations can’t be met, then the profitability of a business becomes an afterthought.
For smaller businesses, maintaining profitability while having a positive cash flow can be tricky, as a lot of cash flow problems faced are not necessarily the fault of the business.
Instead, they might take the form of late-paying customers, rising industry costs or bookkeeping errors.
SMEs typically have thinner cash reserves and proportionately higher operating costs, so cash flow crises can hit them harder.
Moreover, it is not uncommon for owners of smaller businesses to act as guarantors or collateral on loans or leases, making poor cash flow a personal problem.
How can you boost cash flow?
Now we’ve established how important cash flow is, here are some strategies to ensure your business can stay afloat:
- Monitor and forecast cash flow regularly –Creating cash flow forecasts can predict future income and help your business avoid cash shortages.
- Improve client payment terms – If a client is paying late, make sure to chase down invoices consistently and provide appropriate payment options to ensure you are paid on time.
- Keep a cash buffer – A cash reserve is important to overcome any unexpected costs and financial strains you might encounter.
- Be strategic with spending – Building healthy relationships with suppliers can open doors to flexible payment plans if your business is struggling to pay on time. Essential expenses should be prioritised over those that are not needed immediately.
- Funding and grants – Taking opportunities for funding and grants can inject working capital into an SME without adding repayment liabilities or watering down your business ownership.
Talking to a cash flow specialist
Cash flow management is essential for SMEs and often a better immediate indicator of business success than profit.
Understanding that a poor month of profit is outweighed by a poor month of cash flow is crucial, allowing businesses to realign priorities.
Hiring an accountant for your company can provide services that improve cash flow and protect against any risks to personal finances.
While smaller operations may not have the resources to take on an accountant full-time, outsourcing gives the benefits without the additional costs.
Speak to an accountant
If you find your business struggling to stay on top of cash flow, or you think you could benefit from better financial planning in general, it may be time to speak to an accountant.
We offer a range of services to ensure your business is prepared and cash squeezes and unexpected costs are effectively managed.
Our accountants handle a full range of financial planning services, from cash flow forecasting to creating a detailed tax plan.
Is your business strapped for cash? Book a consultation with one of our experts for specialist cash flow advice.