It is possible to have a profitable business and cash flow problems.  It is also possible to have an unprofitable business and no cash flow problems.  Cash flow and profit are two different financial indicators and when operating a business you need to track both.

Cash flow

Cash flow is the money that flows in and out of the business from operating, financing and investing activities.  Operating cash flow is cash from the business’ operations.  Cash flow from financing activities is cash from debt funding, equity funding and the payment of dividends.  Cash flow from investing activities is cash from the purchase or sale of assets and the purchase or sale of securities.

A business can be profitable and have inadequate cash flow

Inadequate cash flow can cause a profitable business to close its doors.  For example, you purchase widgets and sell them at a profit.  The sales chain process is long and customers don’t pay for at least 90 days.

	Days to receipt of funds
Purchase of product to manufacturer	0
Shipping of product from China to Australia	40
Receiving and handling	3
Dispatch and invoicing customer	2
Receipt of payment from customer	90
TOTAL	135

 

In this example, it is 4.5 months from the initial outlay of cash to purchase the widgets until the cash is collected from the sale of the widgets.  You are caught between suppliers wanting to be paid now and customers wanting to pay as late as possible.  You have a profitable and growing business but also have a real cash flow crisis.  You have wages, rent and other operating expenses to pay but no cash coming in.  This juggle becomes increasingly difficult when a business is in the rapid growth phase.

A business can be unprofitable and have adequate cash flow

A business may borrow money from the bank or a personal source.  This cash is used in the short term to fund operating losses.  Or in some instances the business may be profitable but rising debt costs (i.e. borrowing costs and interest expense) may increase the business’ expenses above breakeven point.  Break Even Calculator

Profit

Profit or net income is revenue less expenses. Profit is an indication of your business success but cash flow is more important as it keeps your business operating.  It is the profit that generates cash flow.

A business cannot survive long term unless it is profitable.  As sales revenue grows, sometimes the costs of operating can also increase and cause expenses to be more than revenue (unprofitable business).  It may not be immediately noticeable as the business continues to generate cash from a profitable period.  As such, it is important for a business to monitor profitability.  Access to timely and accurate management accounts, will ensure you are in a position to make accurate and sound business decisions.  It allows an unprofitable business enough time to make the business profitable before it runs out of cash.

Conclusion

While cash flow keeps your business operating, without a profitable business you will not generate sufficient cash flow.  As such, it is important that a business monitors profitability and cash flow.  That’s why all of our clients have a budget, cash flow forecast and timely and accurate management reports which shows budget to actual results.

Setting a budget, identifies the drivers in your business and those profit and loss lines that have the greatest impact on profitability.  Reporting budget to actual gives information to the business owner so that they can identify the under or over performing areas of the business.

Having a cash flow forecast, enables the business owner to identify times when cash flow is tight.  This enables the owner to either, contact debtors for on time payment, push creditors past payment terms or seek short term funding.

 

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