Profit vs. Cashflow: Why a profitable business can still fail.
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Anyone else ever been in that weird twilight zone where the numbers say you're making money but your bank account says, "Umm… no you're not?"
It's enough to drive you nuts. You're pulling in sales, the profit margins are decent, but every time you look at the bottom line, the cash has mysteriously vanished.
Here's the thing most folks miss: Profit and cash flow are NOT the same thing. And a lot of seemingly healthy, profitable businesses go under because they don't get that difference.
I'm obsessed with breaking down complex topics into bite-sized pieces, so let's demystify this whole profit vs. cash flow thing. Here's a metaphor:
Profit is like the scorecard at the end of a sporting match. It tells you who won, but not how the game actually unfolded.
Cash flow is like the play-by-play of the game. It shows you how the money actually moves in and out of your business throughout the contest.
Why should you care? Because you can win the game (be profitable) and still lose the championship (go bankrupt).
Let's illustrate this before diving deeper...
Scenario: Say you run an e-commerce store selling fancy widgets. On paper, you have great margins. But what happens if…
Most of your sales are on credit, where you get paid way later.
You just sank money into a big inventory order.
Your rent just doubled.
Your profit for this period might say "healthy," but that doesn't matter if you can't pay your bills NOW.
That's where the danger lies…
Alright, now that you understand that profit and cash flow are not interchangeable, let's dive into WHY there's this disconnect in the first place.
Here are a few of the major culprits:
The Timing Conundrum: Profit is calculated on a fancy system called "accrual accounting." This is great for getting a big-picture view over time, but it can hide the day-to-day problems. You might recognize revenue from a sale today, even if the customer doesn't pay for 90 days. Likewise, a big expense – like buying equipment – might be spread out over time on your profit statement even though you wrote the check all at once.
Inventory is a Money Suck: If you sell physical products, inventory is your lifeblood and your biggest cash hog. You need to have enough stock on hand, but that money is TIED UP until you sell those items. If you overestimate demand and get stuck with warehouses full of stuff, your perfect profit picture can quickly turn into a cash nightmare.
Growing Too Fast: This sounds counterintuitive, right? Believe it or not, rapid growth can destroy an otherwise healthy business. More customers = more sales = AWESOME, right? Well, only if you have the cash on hand to support that growth. You need money to hire more staff, invest in marketing, scale manufacturing, etc. Often, the profits lag behind these upfront growth expenses.
Debtor Danger: Let's say you're generous (or perhaps disorganized) with payment terms. Customers love you, they just pay... whenever. It's money you'll eventually get, but bills don't care about "eventually."
Key Takeaway: Even if you're profitable according to a spreadsheet, your business can still be on shaky financial ground if your cash flow isn't in sync.
So how do you stay on top of this and avoid disaster?
Here are some practical tools and strategies:
The Cash Flow Statement: Your New Best Friend. If you're not already intimately familiar with this financial document, change that ASAP. Unlike an income statement (which shows profit), the cash flow statement tracks the actual movement of money in and out of your business. Analyzing this tells you if you're generating enough cash to cover your expenses and reinvest.
Become a Forecasting Pro: Don't just react to the past, build models to anticipate your future cash position. This is where spreadsheets become your superpower. Project your sales, known expenses, and even the timing of when you expect things to be paid.
Track Those Key Metrics: Here are a few to watch closely:
Days Sales Outstanding (DSO): How long it takes customers to pay you, on average. Lower is better!
Inventory Turnover:* How quickly you sell through your stock. Higher generally means better cash flow.
Burn Rate: If you are spending more than you make, how many months does the cash you have left last?
Negotiate Like a Boss: Can you get better payment terms from suppliers? Can you convince customers to pay upfront or on shorter cycles? Even small tweaks here can have a big impact on your cash position.
Get Paid FASTER: Make it ridiculously easy for customers to pay invoices. Implement online payment systems, offer discounts for early payments, and don't be afraid to chase those late payers!
A Line of Credit Can Be Your Savior: If you know you have seasonal swings or big expenses coming up, having a line of credit with your bank can provide that safety net to bridge the gap. Don't wait until you're desperate – secure this before you need it.
Key Takeaway: The best way to survive and thrive isn't just about profitability, it's about managing your cash flow proactively.
Wrap Up
Cash flow is the lifeblood of your business. Always remember – It's not how much money you make, it's how much money you keep. Master the art of cash flow and you'll dramatically increase your odds of long-term success.
Until next time,
Scott