- 03 Oct
Why Do Profitable Businesses Sometimes Have Cash Flow Problems?
Why do profitable businesses sometimes have cash flow problems? The answer, is because profitability and good cash flow are not the same thing. Whilst it is more likely that your cash flow will be good if your are profitable, it is far from a certainty.
Why Do Profitable Businesses Have Cash Flow Problems?
The reason that profitable businesses can still have cash flow problems is to do with how quickly their customers pay, versus how quickly they have to pay their creditors. A cash flow problem occurs when you have to pay your creditors sooner than you are being paid by your customers, or if you are trading at a loss i.e. the income from your sales is not covering the cost of sales, regardless of the time taken to pay you.
If you are selling products or services at a profit i.e. more than the cost of producing the products or delivering the services, you can still find yourself having to pay for the supplies, staff costs etc. before you have been paid.
You can make a profitable sale e.g. selling at £1,000 something that cost £500 to supply. At the point of sale you have had to pay out the £500 production cost, and yet you only have an invoice for £1,000 outstanding. So on paper you have make a profit, your accounts will show a profit, but you haven't had any cash in from the sale - yet you had to pay for the production costs. This creates a cash flow problem.
It can also be created by temporary changes in the balance between cash flowing into, and out of your business. For example, if you have seasonal surges in sales volumes. This can drain your cash flow if you need to purchase raw materials, or pay staff to cope with a seasonal sales surge.
For a detailed explanation see our article: Cash Flow Versus Profit.
You can find another worked example of the difference between cash flow and profitability in our article: explaining the differences.
Improving Your Company Cash Flow
There are a number of steps that you can take to try and improve your company's cash flow. These are explained in this short article and video: Improving Company Cash Flow. They include accelerating your cash flow by using invoice discounting to release some of the cash from your unpaid sales invoices.