We often come across organisations that are generally profitable, but have cashflow issues.
A successful business owner asked me recently, “We’re making good money, but we are always running into cashflow problems. How can we be making money, but be having trouble paying our staff and suppliers on time? It’s always a juggle. How can this be, given how profitable we are?”
It’s a great question. Many business owners are very good at providing a great product or service to their customers, but not always so good at running their business.
There’s common confusion around ‘profitability’ and ‘cashflow’, and the relationship between them. To answer the question of the business owner above, we need to define what ‘profit’ and what ‘cashflow’ actually mean. And do so, without getting into an accounting lesson!
Profit is the difference between revenue and expenses. This is no secret; however, this is where the confusion begins. If an organisation generates $100k in revenue, and $80K in expenses, they have obviously made a profit of $20k. However, the mistake some clients make is equating that $20k in profit as equaling $20k in cash (or cash equivalents) ‘flowing’ into the business over the period that the profit was made. Isn't this the case? Well, no. It's not.
To explain, we have to go one step further than simply saying that profit is the difference between revenue and expenses. Profit is the difference between revenue earned and expenses incurred over a period.
There is a difference between earning revenue and receiving payment. During a normal business period, most organisations earn revenue but don’t actually receive payment for that revenue for some time. Invoices have to be generated, then sent to customers who generally have 20 days or so to pay that invoice. Therefore, payment for revenue earned in one particular month may not be received for two or perhaps three months later. In some circumstance, it’s not received at all.
On the other side, there is a difference between incurring expenses and actually paying for them. Expenses are also often incurred in one period but not paid for sometime. For instance, a business incurs expenses for utilities everyday, but may only receive an invoice and pay for those expenses every three months or so. Similarly, payments can often be made in advance. For example, 12 months of business insurance can be paid in one month but incurred in the following 11 months. However, there are of course regular payments that have to be made at fixed times. The most obvious one is the payment of salaries to staff.
It’s important that organisations are profitable. However, it’s also important that organisations actively manage their cashflows. Cashflow problems often cause profitable businesses to get into difficulty. Almost always, that difficulty can be avoided.
If you are having cashflow problems with your business, or you’d like to discuss this issue further or even ask a question on this topic, please feel free to contact the team at any time. We’d be happy to assist you.
James Hamilton & NEIL HALLs
The founders have years of experience across a diverse range of industries and business areas. Their aim is to ensure the team at Clear Path Commercial Consulting use this experience and their individual knowledge and skills to help our clients in their own business.