So you think your Profitable Business Won’t Fail?
You’re rocking it!
You’ve made your first, second or even fifth million (turnover, that is), and on paper, you’ve made a healthy profit.
So why does the bank balance look so small? Why are you still lying awake at night worrying about how you’re going to pay the wage bill or your key supplier at the end of the month?
The simple answer is poor cash flow.
It’s shocking to realise that 90% of the businesses that fail do so because of poor cash flow, whether they’re profitable or not!
The Difference Between Cash Flow and Profit
Cash flow is the basic movement of cash into and out of the business.
In its simplest form, profit is the balance of revenue (turnover) that would be left over once the business has paid all the expenses relating to that revenue.
The key difference between cash flow and profit is that a profit calculation doesn’t consider if an invoice has been paid or if a bill is still outstanding. It is based on what has been logged in the accounting system.
Cash flow is only concerned with what payments have been received and paid. Money flowing through the business could also include loan capital received and loan repayments, which don’t feature in the profit and loss account of a business (they’re in the balance sheet instead).
Many businesses make the common but deadly mistake of focusing on overall profitability but fail to consider cash flow. Never underestimate the absolute importance of cash flow to the health of a business. It is a crucial indicator of financial health, underpins stability and can give better buying power.
The Quality of Your Profit
On the face of it, it would seem that a profitable business must have good cash flow. If income is comfortably higher than outgoings, then surely there is cash in the bank?
Unfortunately, this is often not the case.
Cash flow, to some extent, is a measure of the quality of your profit.
If your profit is, in the main, paid for sales, then it’s high quality. However, if the reality is that most of your profit is still sitting in your customers’ bank accounts, then it’s low quality.
And this is where the trouble starts.
What Causes Poor Cash Flow?
The most common cause of poor cash flow is late payment.
If you have a low volume of high-value invoices, just one or two late payments can have a very detrimental impact on your cash flow as you still have to pay all the overheads associated with that high-value sale.
Even if your debtors are spread over a more significant number of customers with relatively consistent invoice values, it won’t take many late payments to tip your cash flow from positive to negative.
If any of your customers regularly pay you late, then you have a cash flow issue.
What Happens If Cash Flow Is Poor?
It’s hard when a business is in a period of negative cash flow. It becomes impossible to re-invest in the business, and you spend all your time and energy trying to keep your head above water.
Poor cash flow can hamper a business’s responsiveness to the market and opportunities. Businesses that can react quickly to changes in the market or new opportunities are the ones that succeed. If your business doesn’t have the cash available right there and then, even if very profitable, you can’t do this.
Your suppliers really don’t care if you’re a £multi million business making a juicy profit if you can’t pay your bills, and not paying your suppliers on time can impact your credit rating. This doesn’t just affect your standing with them but also with new suppliers and can limit your access to new investment or finance.
In a worst-case scenario, poor cash flow can put an otherwise successful enterprise out of business.
Tackle Late Payments
If your business can’t generate consistent, positive cash flow, it’s going to be in trouble, but if it can, you’ve got real success on your hands.
Let’s be blunt, though; late payments are a symptom, not the problem. Just throwing more resources at chasing invoices will cost you and will not give you any long-term benefit.
You need to address why your customers are paying you late, and the problem isn’t always with them. Sometimes it’s what you’re doing, or more likely not doing that’s the problem.
It’s about making better decisions before making a sale and better tracking once a sale has gone through.
If you don’t have processes and controls to manage the granting, monitoring, and recovery of trade credit, you could be haemorrhaging cash and time.
Tackling the root cause of late payment by improving your processes will improve your cash flow AND your profitability, possibly even your sleep!
And that has to be a win all around.
If you’d like to find out what you could be doing differently to prevent late payments and boost your cash flow, why not book a call with us today.