As a business owner, you likely keep a close eye on your cash balance and maybe less so on your profitability. Both metrics offer critical insights into the financial health and sustainability of your company. However, it's important to understand that cash in the bank and profit do not always go hand-in-hand.
Reasons You Can Be Profitable But Cash Poor
There are a few key reasons why a business may be making a profit without having the cash to show for it:
Clients paying later - If you offer credit terms to customers, you may have to wait 30, 60 or even 90 days to collect payments after making a sale. You made the sale but you won't have the cash in hand until later.
Inventory/Stocks or Supplier Bills - Selling products means you have money tied up in inventory. You may have to pay for this stock before you get the chance to sell it and collect the cash for it.
When providing services, you pay your staff at the end of the month they have worked, yet you may not charge the client until the following month and get the cash in another 30 days later.
Investing in Growth - When aggressively spending on new equipment, R&D, hiring, facilities and other investments for future expansion, short-term cash flow takes a hit even if profits rise over time.
The danger of this disconnect is that you may not have the working capital needed to keep funding operations, make payroll, and pay near-term obligations.
Reasons You Can Have Cash But Be Losing Money
On the other side, it's also possible for a company to have strong cash reserves or cash flow but still be losing money when profits are calculated:
You may how money to the tax man for VAT. This money is in your bank and strictly speaking is not yours and it is not profit you have made.
Customers may be paying you deposits for goods and services you have not delivered yet. This money has not been earned yet, and you may have to make some refunds.
In these cases, you could be tempted to spend money that is not yours and find yourself short when that debt is called in. Monitoring both metrics is vital.
The key in any business is finding the right balance between profitability and cash flow over both the short-term and long run. Understanding when and why these two critical measures may not fully align is the first step toward maintaining this balance and financial health.
If you have concerns over your profitability or cashflow and need clarity on your position and how to improve it, send me a DM and I will be happy to have a free insight call with you.
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