It can seem confusing for a business to be profitable while also experiencing cash flow problems.
However, this is a situation that many SMEs find themselves in.
Having a healthy profit does not necessarily mean that there is enough money available in the bank to cover the business’s immediate costs.
For SMEs, being able to manage the difference between money that is expected and money that is actually available is an important part of maintaining financial stability.
Why does profit not equal cash flow?
Profit is a useful way for businesses to understand whether they are operating successfully and gives a better indication of performance than looking at turnover alone.
However, having a healthy profit margin does not necessarily mean that a business has healthy cash flow.
One of the biggest issues that can impact cash flow is late payments. If a business is expecting to receive £50,000 from a project in September but does not receive the money until January, the business still has to cover its costs in the meantime.
The business may have expected this money to cover payroll, rent and project-related expenses, but instead it now has to find a way to cover those costs for another four months.
However, late payments are not the only factor that can cause cash flow problems. SMEs can also experience issues due to excess inventory, increasing overhead costs, unexpected expenses and periods of rapid growth.
There is also a difference between real and expected profitability. Realised profitability is the actual financial gain a business has made after an accounting period, while expected profitability is the amount that a business forecasts it will make in the future.
Having an idea of expected profits is important for businesses as it can help them plan future investments and give owners an indication of how much profit they may be able to extract.
However, relying too heavily on these forecasts can create problems as businesses can be affected by unexpected changes in the real world.
How can businesses improve their cash flow?
Maintaining healthy cash flow is essential for businesses to ensure that they can continue to meet their financial commitments and avoid becoming insolvent.
Some of the key ways that businesses can improve their cash flow include:
- Monitoring cash flow regularly – Regularly monitoring and forecasting cash flow can help businesses identify potential shortfalls and prepare for periods where cash may be limited.
- Keeping a cash buffer – Businesses can hold on to cash until bills are due and review their regular expenses to remove any unused subscriptions. This can help slow down outgoing cash and provide a buffer for unexpected situations.
- Reducing late payments – Businesses should aim to send invoices as soon as projects are completed. Asking clients for deposits before work begins can also help improve cash flow. Automated payment reminders can also make it easier to follow up on outstanding invoices.
- Keeping cash available – Businesses should avoid having too much cash tied up in inventory or equipment. Selling unused stock and considering renting or leasing expensive equipment rather than buying it outright can help businesses keep more cash available in the bank.
Keeping on top of cash flow is essential for SMEs so that they do not rely on profit margins alone when measuring their success.
How can we help?
Understanding that profit does not always mean healthy cash flow is crucial for businesses that want to protect themselves from poor cash flow management.
Our team can help you forecast your cash flow and make sure that you do not get caught up in the idea that profit alone equals success.