While profit and cash flow are intertwined, they give two very separate insights into the financial performance of a business.
It is easy for smaller businesses to assume that making a profit equals good financial health, but this, in isolation, rarely provides the complete picture.
Profit vs cash flow – two unique indicators
While profit is an essential component of a successful business, it does not reveal real-time cash health.
A business can be making money on paper, but does it have enough liquid assets to pay bills and meet obligations? Profit alone is not the answer.
This is where cash flow comes in.
Cash flow focuses on the inflow and outflow of money into the business bank account, recorded in a cash flow statement.
A positive cash flow indicates a business has enough liquidity to cover wages, suppliers and tax liabilities, amongst other expenses.
It is possible to have negative cash flow in a profitable business if income is delayed or costs are paid up front.
Profitable, but broke – When is cash flow king?
As an example, imagine a business invoiced £25,000 for a project in March but wasn’t to get paid until June.
On paper, the business has made £25,000 as soon as the invoice is submitted.
However, it still must cover payroll, rent and the costs of delivering projects in the three months before this money hits the account.
If you took that situation and multiplied it across several different projects, a successful business could find itself on the brink of insolvency.
Why this is even more of a challenge for SMEs
The balancing act between maintaining profitability and a positive cash flow hits SMEs particularly hard.
Common cash flow problems are not necessarily performance-related. They can arise from late-paying customers, rising overhead costs or even minor bookkeeping errors.
For smaller companies with thin cash reserves, small numbers of clients and proportionately higher fixed costs, the pressures are felt much more.
Also, many SME owners can act as guarantors on loans or leases, meaning cash flow issues are not always a business problem but a personal one too.
An accountant can help to solve these problems by providing services that can shield small business owners from cash flow crises and personal financial risks.
Smaller operations may not have the resources to hire an in-house accountant, so outsourcing can give them the benefits without additional costs.
Five cash-flow management techniques
Considering how important cash flow is for day-to-day operations and business success, here are some strategies to ensure it remains positive.
- Monitor and forecast cash flow regularly – create rolling cash-flow forecasts to predict future income and avoid cash shortages.
- Improve payment terms – chase invoices consistently and offer multiple payment options to clients.
- Keep a cash buffer – costs can arise when you aren’t expecting them, so cash reserves can prevent financial strain.
- Be strategic with spending – explore whether it is possible to negotiate flexible payment terms with suppliers. Prioritise essential expenses whilst delaying those that are non-critical.
- Funding and grants – funding and grants can inject working capital into an SME without adding repayment liabilities or watering down business ownership.
Seeking professional advice
It is important to understand that a bad month of profit is outweighed by a bad month of cash flow, especially in the case of SMEs.
Many bad cash flow situations do not necessarily come from bad decisions, but from bad timing.
If you find your business is struggling to meet cash obligations, or you feel it could benefit from better financial planning, you could benefit from professional advice.
Our team will help you create cash flow forecasts and tax plans that will help you flag problems early.
Reach out today to become more confident with cash flow.