Turning a Profit but Can’t Pay the Bills: Managing Your Cash Flow

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Dear CFO:

My business earned a profit for the last two years, but we still can’t pay the bills. How did this happen and what should we do? 

Vendors are calling in Chicago

You aren’t the first person to ask this question or run into this situation. It’s a common misconception among beginning business owners: that showing a profit means you’re successful. Earning a profit doesn’t mean business success because profit doesn’t equal cash. This principle is especially true when:

  • customers don’t pay cash to for purchases and are given a month or more to pay, creating accounts receivable.
  • vendors allow you to pay your bills later, also known as accounts payable.
  • you need to invest in equipment, inventory or other assets.
  • you need to pay loans and other bills.
  • you must pay dividends to your investors.

And, as we all know – cash is king!  The ability to generate cash flow is the primary financial objective of any business. Without cash, you can’t pay the bills! To understand the real financial landscape of business, it’s important to understand the meaning of cash flow.

Understanding the Concept of Cash flow and How Problems Happen

Cash flow is how much actual money goes in and out of your business each month. As I explained above, being profitable doesn’t guarantee success. If you can’t pay the bills, you may have a cash flow problem. Activities that don’t immediately impact your profitability (buying equipment and inventory or paying off debt) still require cash.

How Does a Cash Flow Problem Happen?

Well, first of all, timing is critical. Sales bring in cash. Buying goods and services require cash. It’s synching up the timing of the two events that give small businesses headaches.

Even if you receive on-time cash payments from your customers, it’s likely your business isn’t really a “cash basis business.”  Why not?  If all your customers don’t pay immediately for the product they purchased, you record the sale of the product and yet there’s no cash. If you don’t pay your vendor immediately on delivery of your purchase, again, no cash has changed hands, yet a transaction took place.

To explain this concept of cash flow with an example: Let’s say your customer agrees to pay you in 45 days. You agree to this deal, BUT your vendor wants their money in 30 days. This 15-day gap will cause the problem you described – “I earned money but still can’t pay my bills.” Because you sold the product, the income statement says you earned money, but the customer hasn’t paid yet. At the same time, your vendors are looking for their payments.

Other Cash Needs Affect Cash Flow

Outside of sales and paying vendors, your cash needs still affect your cash flow as well. So, synching up the timing of customer and vendor transactions isn’t the only concern as you plan to pay your bills. While your business may earn a profit, consider any cash you need to take off to pay bank loans or buy equipment to support your sales.

This is one of the key reasons I REALLY encourage cash flow planning as part of the budgeting process. Budgeting isn’t only creating the income statement (or profit and loss as some call it); budgeting is also managing the balance sheet.

Accrual accounting works on the premise of matching expenses (a.k.a. your business bills) with the income (business sales) generated– even if you haven’t received the bill from your vendor yet or the customer hasn’t paid. A time continuum further hurts your ability to pay the bills, even though you sold the product. Most businesses focus on the income statement (I made money!!), but the balance sheet (what do I have and what do I owe?) is what causes the cash flow problem. This requires your business to also create a cash flow statement. This statement not only accounts for the items described above but additional items requiring and/or generating cash. These items might include equipment purchases, customer deposits or debt payments.

As you plan for your business, it’s important to understand what you’ll need to spend to:

  • create, distribute, sell and support your product (typically reflected in the income statement)
  • acquire assets (inventory, equipment, and accounts receivable as reflected in the balance sheet), and
  • pay off any loans or vendors (also, reflected in the balance sheet).

It’s also critical to consider the timing of the cash coming in versus the outgoing cash.

How Do You Avoid a Cash Flow Problem, When You Can’t Pay the Bills?

To avoid a cash flow problem, it’s important to know your numbers to adequately plan for cash needs. These important numbers might include: 

  • # of days sales in accounts receivable
  • # of days COGS (cost of goods sold) in accounts payable
  • # of days sales in inventory
  • Amount and due dates of upcoming loan payments
  • Amount for purchases of additional equipment needs

Recognizing and planning with these numbers will help you identify potential cash flow timing and shortfall issues.

Once you’ve pinpointed the important numbers, plan to address them. Many small businesses alleviate timing issues on the customer side by accepting credit cards. Depending on your business, the 3% to 5%+ credit card transaction fees are worth the expense to eliminate collections costs and speed up cash flow.

If you’ve carefully analyzed equipment needs, consider financing purchases through a bank loan to avoid using up cash reserves. Leasing is often an equally appealing idea as there is frequently 100% financing options available.

Negotiate terms with vendors to increase the time between their shipment and the due date for your payment. Ideally, (although unlikely) try to settle on terms to match your sales cycle.

Establish JIT (Just in Time) and/or build-to-order systems to reduce the amount of cash required to buy inventory. This isn’t an option in a retail establishment, of course. In my experience, large customers typically push the inventory requirements to their vendor. A large customer may demand JIT system of your business. If your business doesn’t have the capacity, you’re required to hold more inventory. It’s important to consider this type of situation when pricing as well as projecting cash flow needs.

Renegotiate debt agreements for longer terms or seek SBA financing to lower debt payments. (Please contact me if you need a referral to an SBA financing specialist.)

Keep in mind, if you can’t pay the bills it’s a stressful problem you’ll want to resolve immediately. However, fixing a cash flow issue may take time and require system adjustments. The suggestions here aren’t overnight implementations and they may require further cash expenditures to implement systems to support the changes.

As you run your business remember cash is king. See more ideas on managing a cash flow crisis or contact us for two hours of complimentary consulting to help you get on track.

Featured image by FreeGraphics; post images by Skitterphoto and Pexels. All images via Pixabay and licensed for use under CC 1.0.

About Author

about author

Lynne Robinson

Lynne brings years of experience in service industries, manufacturing, leasing and corporate finance. She started CEO Buddy to help small business owners grow their businesses.

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