Some entrepreneurs may believe that their business is performing strongly when the income statement shows healthy profits. However, this is not always the case. Oftentimes, business owners will find themselves in a situation where they are making a profit but no cash flow.
A profitable business can also struggle to clear its bills and supplier payments. This is a common issue which requires careful consideration and understanding of cash flow vs profit difference and why business has no cash flow.
We will walk through the main cash flow problems in business, cash flow management strategies and how to improve cash flow in business.
Cash Flow vs Profit Difference
Some may believe that profit and cash flow are the same, but this is not the case. Cash flow represents the actual flow of cash in and out of your business. On the other hand, profit is the income left after deducting all expenses, cash or non-cash.
If you make a sale today, you can record that as revenue and reflect it in the income statement, even if the customer has not paid you yet. This gap between cash inflow and sales recorded is just the beginning of most problems.
Major Factors For Cash Flow Problems in Business
Typically, it is a combination of factors that lead to a drain in your cash flow even though your profits may seem healthy. Some of these factors are:
- Delayed Credit Terms with Customers: One way to attract customers is to offer relaxed credit terms, such as 30 days, 60 days or even 90-day payment terms. While it may seem like a great idea, especially for the top line, your cash is stuck in trade receivables. At the same time, expenses such as utility bills, salaries and rent demand quick payments.
- High Inventory on Hand: When inventory is slow to sell, cash gets tied up. Similarly, holding too much inventory can also tie up cash unnecessarily. While these items may be profitable, cash ends up being locked up until the sale occurs.
- Debt Repayments: Some businesses may have hefty loans on their balance sheets that require principal repayment. Repayment of loans do not show up on the income statement but significantly affect your cash flow.
- Capital Expenditure: Similar to debt repayments, investing in equipment, machinery or furniture does not show up in the income statement but can severely drain your bank account, although your business is profitable. Also, rapid growth can result in heavy marketing spend and higher staff salaries, draining your bank balance. Timing mismatches unnecessarily creates a cash shortage.
- Lack of Cash Flow Planning: Cash flow forecasting is essential in planning for future cash shortages. Without proper cash flow management strategies, liquidity shortages can suddenly arise.
- Withdrawals: Owner withdrawals, if taken as cash can also affect your business cash flow. While your business may be showing strong profits, withdrawals can take a toll on your cash flow. Owner withdrawals are not shown on the income statement, so careful analysis of the balance sheet and other financial statements are essential for better understanding of where your money is going.
Warning Signs of Cash Flow Problems in Business
There are many signs that your business is profitable but struggles with cash flow such as:
- Unable to pay bills timely
- Using credit cards or taking on loans to pay for expenses
- Unstable bank balances
- Struggling to pay your suppliers on time
- Constantly being under pressure to fulfill payments despite healthy sales
How To Improve Cash Flow In Business
- Motivate Receivables: You can reduce credit days for customers to pay quicker, say within 2 weeks instead of a month. Cash discounts can also be offered to customers to pay before time, which can adversely affect your profit but can bring in cash when funds are scarce. Business owners should automate invoice generation and send them out as soon as possible. Constantly follow up with customers to ensure payments are not overdue.
- Improved Billing Processes: Invoices should be clear and easy to understand. Businesses should use cloud accounting systems for automated invoicing, to simplify and standardize invoice layouts, and should also be flexible with payment methods, such as allowing payments through cash, online, digital wallets etc.
- Inventory Management: Amongst the several cash flow management strategies, inventory management comes high on the list. This means that businesses should focus on demand forecasting, avoid overstocking, get rid of slow-moving items by offering discounts or consider vendor-managed inventory or just-in-time inventory if possible.
- Negotiate Better Terms With Suppliers: If you have to pay suppliers in a week while customers pay after a month, you already have a mismatch in cash flow. This is why your business is profitable but has no cash flow. Try to negotiate more favorable payment terms with suppliers to reduce the gap between receivable days, and focus on building strong relationships for added flexibility. Even a few extra days can reduce stress significantly.
- Cash Buffers: Consider building cash reserves to protect yourself during slow business cycles. Set aside a set portion of your profits every month in a separate account for taxes or for unexpected times. This can give you some breathing space in case cash from operations suddenly becomes short.
- Financial Statements: The income statement only shows the total income and expenses for the period in consideration, regardless of whether cash exchanged hands. It does not show where your cash is going, any debt repayments, investments, etc. It is equally important to go through the cash flow statement and balance sheet for a detailed view of the business’ true cash position.
- Financing: By using proactive cash flow forecasting techniques, such as analyzing the timing of cash flow and the amount of money flowing in and out of the business, you can strategically plan on how to improve cash flow in business. This can be done through invoice management, applying for lines of credit or taking short-term loans. Instead of having profitability as your main objective, focus on understanding the incoming and outgoing cash flow for the following periods to stay well-informed in advance.
- Profit Analysis: Ask yourself why your business is profitable but has no cash flow. Go through your expenses, see what subscriptions are not needed, determine if any expenses can be delayed or if cheaper alternatives exist. This can keep your business both liquid and profitable.
- Professional Assistance: Business owners are typically stuck in day-to-day operations and often lack the time required for bookkeeping and analyzing financial information. This is why entrepreneurs should consider opting for accounting professional guidance, which can help them not only save up on time but grow their business sustainably.
The real goal should not just be making healthy profits, but healthy cash flows. Cash flow is the lifeblood of any business. A loss can be handled for some time but a shortage of cash can be detrimental and result in the seizing of business operations. By focusing on cash flow and aligning payments with inflows, you will see your business moving towards long-term sustainable growth.
Struggling with cash flow even though your business is profitable?
Our accounting experts can help you:
✔ Track real-time financial performance
✔ Improve cash flow forecasting
✔ Optimize invoicing and collections
