Your Business is Making Money – So Why Does Cash Still Feel Tight?

You look at your profit and loss statement and see that your business is profitable. Sales are coming in, customers are buying. On paper, things look pretty good. Then you look at your bank account and wonder where did all the money go?

If you’ve ever asked yourself that question, you’re definitely not alone. One of the most common challenges I see with growing businesses is the disconnect between profitability and cash flow.  The two are related, but they aren’t the same.

Profit doesn’t always mean cash in the bank. Your profit and loss statement tells you whether your business generated a profit over a certain period of time. It doesn’t necessarily tell you how much cash is available today.

For example, imagine your business completes $50,000 worth of work this month. From an accounting perspective, you may have earned that revenue. But if your customers do not pay you for another 30, 45 or even 60 days, you do not have $50,000 available to pay today’s bills.

Meanwhile, payroll is due Friday. Your vendors still expect payment. Your loan payment is coming out. Insurance is due. And, you may need to purchase materials or supplies for the next job. Suddenly, a profitable business can feel very cash poor.

You wonder, where is the cash going? There isn’t one answer. Cash can get tied up in several areas of a business:

• Accounts receivable – you made the sale, but you’re yet to collect the money. As receivables grow, your income statement may look great while your bank balance tells a different story.
• Debt payments – your business may be profitable while a significant portion of its cash is being used to repay loans, credit cards, equipment financing, or other obligations.
• Large purchase – Equipment, vehicles, inventory, materials and other investments can require significant cash even though the accounting expense may be recognized differently over time.
• Owner distribution – Money taken out of the business doesn’t simply disappear, but it does reduce the cash available to operate and grow the company.
• Growth itself – this one surprises many business owners because growth requires cash.

Landing a large contract sounds great but what happens if you have to hire additional employees, purchase $20,000 of materials and cover several weeks of payroll before your customer pays their first invoice? The business may be growing and profitable while simultaneously experiencing a cash crunch.

Another mistake business owners make is managing the company primarily by looking at the bank account. There’s $80,000 in the account, so things must be going well. Wrong!

Some of that money may already be committed to payroll, taxes, vendor payments, debt obligations or upcoming projects.

The better questions isn’t simply: “How much cash do I have today?” “It’s: “Based on what’s coming in and what’s going out, how much cash am I likely to have 30, 60, or 90 days from now?”

That’s where financial planning becomes incredibly valuable. You start looking forward, and not just backward.

Financial statements are important because they tell you what has already happened in your business. But business owners also need tools that help them decide what happens next. That’s where budgeting, cash-flow forecasting and regular financial reviews come in.

A good financial process should help you answer questions such as: Can I afford to hire another employee? Can I purchase that piece of equipment? What happens if one of my largest customers pays 30 days late? How much revenue do I need each month to cover my operating costs? If sales increase by 20%, how much additional cash will I need to support that growth?

Those are management questions, and not just accounting questions. And you shouldn’t have to wait until tax season or the end of the year to answer them.

Your business can be profitable and still have cash-flow problems. Understanding the difference is one of the first steps toward building a financially stronger business.

Take a few minutes this week and look beyond your bank balance. Look at what customers owe you. Look at what you owe others. Look at your upcoming payroll and expenses. Look at how quickly you’re collecting your receivables. And most importantly, start thinking about where your cash position is headed and not just where it stands today.

Knowing that your business made money last month is important, but knowing whether you’ll have the cash you need three months from now is how you plan what’s next.

About the Author

Abbey Fajimolu is the founder of FFG Advisory and a member of the Mansfield Business Alliance. With over 20 years of experience in accounting and finance, Abbey brings a diverse background spanning alternative investments, manufacturing, construction, and nonprofit organizations. Throughout her career, she has worked across both the operational and strategic sides of finance, giving her a practical understanding of the financial challenges businesses face at different stages of growth.