Cash flow vs profit: Why your profitable business may still be struggling

For many business owners, seeing healthy profits on your income statement may be misleading. Your business might show impressive profits, yet you’re constantly struggling to pay suppliers or meet payroll obligations. This disconnect between profit and cash flow is a common challenge that catches many business owners off guard.

Understanding the fundamental difference

Profit is what you see on paper – it’s the difference between your revenue and expenses over a specific period. However, cash flow is the actual money moving in and out of your business in real-time. Think of profit as the score on your report card, while cash flow is the money in your wallet to buy lunch.

Why the disconnect occurs

1. Timing of payments

• Income recognition vs cash receipt: Your business might record a R100 000 sale in June, but if your client only pays in August, you’ve got profit without cash.
• Supplier payment terms: While you might need to pay suppliers within 30 days, your customers might take 60 to 90 days to pay you, creating a cash flow gap.

2. Challenges

• VAT Payments: You might need to pay VAT to SARS before collecting it from customers.
• Provisional Tax: Tax payments based on projected profits can strain cash flow, especially in growing businesses.

Common cash flow traps

1. Rapid growth

Growing too quickly can be dangerous. While your profit margins look healthy, you need more working capital to:

• Stock additional inventory
• Hire new staff
• Invest in equipment
• Fund larger operating expenses

2. Seasonal fluctuations

• Tourism-dependent businesses might show annual profits but struggle during off-peak seasons
• Construction companies often face delays during rainy seasons
• Retail businesses need to stock up before peak seasons, requiring significant cash outlay

Warnings your business has cash flow issues

• Consistently late supplier payments
• Regularly maxed-out overdraft facilities
• Difficulty meeting payroll dates
• Turning down new opportunities due to cash constraints
• Relying heavily on credit cards for business expenses

Practical solutions for better cash flow management

1. Improve collection processes

• Implement early payment discounts
• Use debit orders for regular clients
• Consider invoice factoring for large accounts
• Send invoices immediately after service delivery
• Follow up on overdue payments promptly

2. Manage supplier relationships

• Negotiate longer payment terms with suppliers
• Take advantage of early payment discounts when cash is available
• Maintain open communication about payment schedules

3. Smart working capital management

• Keep inventory levels lean
• Consider consignment stock arrangements
• Review your pricing strategy regularly
• Monitor your break-even point

4. Leverage technology

• Use cloud-based accounting software for real-time financial visibility
• Implement automated payment collection systems
• Use cash flow forecasting tools
• Monitor key metrics through dashboard reporting

5. Build cash reserves

• Maintain an emergency fund covering three to six months of expenses
• Consider opening a separate high-interest business savings account
• Reinvest a portion of profits back into the business

Professional support

Consider working with your accountant to:

• Develop detailed cash flow forecasts
• Review and optimise your business cycle
• Structure appropriate financing solutions
• Implement robust financial controls

Looking ahead

While profitability is crucial for long-term success, managing cash flow is essential for day-to-day survival. As a business owner, you need to be particularly mindful of:

• Economic fluctuations affecting payment patterns
• Exchange rate impacts on import-dependent businesses
• Infrastructure challenges requiring cash reserves
• Seasonal variations in your industry

Key takeaways

1. Profit and cash flow are different metrics requiring separate management strategies
2. Growth periods often create cash flow pressure despite increasing profits
3. Regular cash flow forecasting is essential for business sustainability
4. Building cash reserves provides crucial business resilience
5. Professional guidance can help optimize your cash flow management

Many profitable businesses fail because of poor cash flow management. By understanding and actively managing the relationship between profit and cash flow, you can build a more resilient and sustainable business in today’s dynamic economic environment.