Before we demystify how a profitable business can have cash flow problems, it’s important to understand the difference between profit and cash flow. Cash flow represents the closing balance of a business after deducting the cash paid from the cash received in a given trade period. Any business needs to have a positive cash flow to handle the day-to-day expenses. On the other hand, profit represents the balance between the revenue and expenses incurred after every sale.
Recent studies show that more than 80% of small businesses fail due to cash flow problems. This statistic is alarming, yet sadly many of these closures could've been avoided with the proper cash flow management system in place. And, accessing capital at the right time. So, what could be the main cause of negative cash flow for a profitable business?
Growing too fast
Most entrepreneurs get overwhelmed by the progress of their business and seek to open other locations too soon. This can lead to over-trading, which puts a lot of pressure on short-term finances. The main problem occurs when the new locations have to rely on the already established ones before they start generating profits. This can often lead to major cash flow problems.
Small Business Growth Capital, Explained. And When Your Business Needs It.
Paying for expenses in advance could mean that there will be more cash going out than coming in. For instance, paying for insurance has a negative effect on the cash flow because there will be no money flowing in to cover this deficit. Such expenses are necessary, but they reduce the amount of cash available to keep the business afloat.
Giving too much credit
While offering goods and services on credit can attract more sales, it can also lead to major cash flow problems. Late repayments and bad debts leave your business with no cash to operate.
Acquiring long-term assets
Using the cash you have to buy new equipment for the business will create a big gap, because more cash will be going out than coming in. It's good to budget for such expenses after a trading period, once the accounts have been reconciled and profits identified.
Paying for loans
Loan repayments can also have a serious effect on cash flow because once the money is paid, only the loan interest is recorded as an expense when calculating profits. However, loan repayment means that more cash will be going out, not just the interest. This leaves a negative balance on the cash flow, which may not be reflected when you come to calculate your profits.
You can avoid cash flow problems by seeking professional financial assistance by LVRG, the #1 name in small business cash flow funding. Click here to contact us for the best financial advice pertaining to growing your business, or click the button below to apply for funding.