Profit vs Cash Flow
This is a question many small business owners have found themselves asking after their profitable business has failed. Many small business owners are caught completely off guard. Because their business is showing a healthy profit they often do not realise that they have a problem until it’s too late.
Dun & Bradstreet report that ninety percent of small business failures are caused by a lack of cash flow, or in other words, as a result of poor management of the money coming in and going out of a business. A lack of cash flow in the short term can often be a breaking point for many small businesses, even though they are profitable in the long term.
Profit and cash flow are two separate things which many small business owners fail to recognise.
For instance, a business could have a very high profit margin and be experiencing strong growth but at the same time have trouble paying its suppliers on time.
So, what is the difference between profit and cash flow?
Profit is the financial gain or the difference between the money earned and the money spent by a business; while cash flow is the amount of money moving into and out of the business.
On paper the business may be showing a profit but if debts have not been collected on time the money that is owed to the business but not yet collected may result in a cash flow problem. If debts owed to the business are not collected it may result in a profitable business failing because it is not able to pay its suppliers.
You need to understand and account for the timing differences between paying your creditors and receiving payment from your debtors. You may need to review credit terms to your debtors and also ensure the number of days outstanding is not increasing. Many small business owners fail to track the number of days debts are outstanding or overdue and the slow payment of debtors can result in a profitable business failing.
As a small business owner you should be asking your bookkeeper to prepare regular profit forecasts as well as cash flow projections. These reports are invaluable and will help you to be alerted to any possible cash flow problems before they arise.