Why do profitable businesses still face cash flow challenges?

Unfortunately, a business can be profitable and still face cash flow challenges. While this may seem nonsensical, it is an issue that many SMEs face as they balance liquid funds against everyday realities.

For SMEs, understanding how to turn profits into cash flow, or at least managing the gap between order sheets and what sits in the bank, is imperative to keeping their business viable.

Why does profit not equal cash flow?

Profit is an excellent way for businesses to see if they are operating as intended, more so than just turnover alone.

However, a strong profit margin does not always mean that the business’s cash flow is strong.

One of the main issues associated with cash flow is late payments. If a business expects to receive £50,000 from a project in September but doesn’t receive it until the following January, the entire supply and operations chain is waiting to be paid.

The business expected that money to cover payroll, rent, and project-related costs, but now it has to foot that bill for four months.

However, late payments are not the only issue that can affect cash flow. SMEs can face issues surrounding excess inventory, rising overhead costs, unexpected expenses and rapid growth.

There also comes an issue with real vs expected profitability. Realised profitability is the actual financial gain that is in your pocket after an accounting period, whereas expected profitability is the forecasted amount that you believe you will make in future.

All businesses want an estimate of what they think they will take in profits, as it helps them to plan investment or gives owners an idea of profit that can be extracted.

However, this could cause harm if they rely on these estimates, as it makes them highly susceptible to real-world deviations.

If businesses fall short of these projections, cash flow issues can soon follow, along with disappointed investors and compromised strategic goals.

How can businesses boost their cash flow?

Maintaining a healthy cash flow is imperative for a business so that they don’t end up insolvent.

Some of the key ways a business can boost its cash flow are:

Monitoring cash flow regularly – Monitoring and forecasting cash flow can allow businesses to prepare for shortfalls and help businesses avoid shortages.
Keep a cash buffer – By holding on to cash until the exact date that bills are due and cancelling unused business subscriptions, businesses can slow down the outbound cash, giving them a buffer for uncertain moments.
Mitigating late payments – Businesses should send their invoices the same day that projects are finished, ask clients for deposits before any work is started and they should be automating reminders for payments so that they can be sure that their invoice is on the debtor’s mind.
Keeping cash free – Businesses should not be keeping their cash tied up in inventory and equipment. Instead, they should try to shift any unused stock and they should rent or lease expensive equipment instead of buying it outright, keeping that vital cash in their bank account.

Keeping on top of cash flow is essential so that SMEs don’t rely on profit margins alone for their success.