Why profit and cash flow are not the same thing

Business owners think in profits, but of course spend in cash. Cash in this scenario, doesn’t mean notes or coins, but money in the bank that you can spend at any time.

A typical business plan may contain details of a product or services that the new business is selling. It has worked out what it could be sold for, minus the costs and expenses of producing it, which in turn produces the profit. But profitable companies can still go bust because all their money is tied up in assets and they can’t pay their bills.

A cash flow problem or a profit problem

Businesses often talk about “having a cash flow problem” when what they have is a profit problem i.e. they aren’t making any or its being eaten up by the drawings of the owners. But its trendier (and perhaps easier to admit than the truth) to say that you have a “cash flow problem”. If it’s a profit problem then there are whole load of other issues link to the improving your profit article that need to be considered which are not the purpose of this article.

Understanding the link between profit and cash flow is crucial if an expanding business is to survive its first few years. It is easy to get drawn into a spiral of cash flow problems even in a business where the underlying trade is profitable. Once in, it is difficult to break free from the spiral.

A proper cash flow problem is where you are making profit but it’s not turning into cash quickly enough because its tied up in paying for new equipment, increasing stock or work in progress or perhaps simply customers who owe you money. Whatever the cause, a number of things can happen when a business has a cash flow crisis including:

  • The business is constantly ‘fire-fighting’ to stay afloat
  • Errors increase as staff and owners are strained
  • Necessary costs are not incurred (perhaps new staff or equipment)
  • Staff morale falls
  • Customers lose confidence
  • Management time is taken away from carrying out other important tasks

This can be a terminal spiral. Once you have identified an impending cash flow problem, what do you do next?

How to avoid a cash flow crisis

To avoid a cash flow crisis, a cash flow forecast is crucial. Then there are some key steps to undertake:

First of all, the business needs to see where it can reduce its need for finance. The most obvious solution is to slow down and not grow quite so fast but opportunities can disappear fast and most new and emerging businesses want to maximise the opportunity. The next is to look at whether the need for finance by improving billing processes, optimising stock levels or maybe better credit control. Automated credit control programmes like Chaser can improve customer payment periods considerably.

Once those options are exhausted then you may need to consider new sources of finance including;

  • Personal funds perhaps secured against assets of the company
  • Bank loans or increasing overdraft
  • Other finance secured against assets or stock
  • Factoring or invoice discounting (see expandable section below)

What is Factoring or invoice discounting?

If you want a more bite-sized approach to helping your cash flow then why not start with our session “Cash Collection Review”. To find out more and book in your session, complete the form below.

A4G also provide our Improve and Grow session entitled ‘Improving cash flow‘. This has been designed specifically to help you tackle these cash flow issues by considering your current position, the sources of finance available and reducing the need for finance. At the end of the session we will produce an action plan to enable you to implement these changes and improvements. This session has already helped many of our clients through challenging times.

If you are concerned about your cash flow, please contact one of our Principal Advisers on (01474) 853 856 today. If you want a more bite-sized approach to helping your cash flow then why not start with our session “Cash Collection Review”. To find out more and book in your session, complete the form below.

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Call us on (01474) 853856 and we will put you in contact with one of our advisers, or send us an enquiry by clicking below.

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