Profitability is often seen as one of the clearest signs of a healthy business. But a company can be making a profit on paper and still find itself struggling to pay suppliers, wages or other day-to-day costs. The reason is simple: profit and cash flow are not the same thing.
Profit measures income against expenditure over a period, while cash flow is about when money enters and leaves the business. This distinction is particularly important for business-to-business companies that sell on credit. You may have made the sale and recorded the income, but if your customer does not pay for 30 days, or pays late, that money is not yet available to meet your own commitments.
Without effective cash management, a profitable business can find itself facing a cash shortage. Working with a chartered accountant can help you look beyond headline profit figures to understand your cash position and identify potential pressures before they become a problem.
When growth puts pressure on cash
Growth can make this problem even more pronounced. A rapidly expanding business may be generating more sales and profit, while simultaneously increasing its outgoings. It might need to purchase more materials, increase stock levels, recruit employees or pay additional suppliers before receiving payment from customers. This can result in overtrading, where a business grows faster than its available working capital can support.
Importantly, this risk is not limited to start-ups or early-stage businesses. Any significant period of growth can put pressure on cash, including an established business aiming to increase in size, entering a new market or territory, or undertaking a project requiring significant investment.
Understanding debtor days and creditor days is therefore important. These should be treated as key performance indicators, helping business owners understand how quickly cash is coming in compared with how quickly it needs to go out.
Spot the warning signs early
Cash flow problems rarely appear without warning. Regular management accounts can help business owners identify potential challenges earlier by encouraging them to look closely at their financial position rather than relying solely on headline profit figures.
Increasing debtor days can indicate that credit control needs attention, while difficulty paying suppliers is an obvious warning sign. Regularly using short-term finance simply to plug gaps in working capital should also raise questions about whether there is an underlying cash flow problem.
Cash flow forecasting is an important part of good financial management. Generally, looking 12 months ahead can provide useful visibility, although forecasts should extend further when a business has a longer-term growth plan or significant project ahead.
Crucially, a forecast should not be created and then forgotten, it should be part of a business’s ongoing financial reporting and budgeting. Comparing forecasts against actual performance helps identify where expectations are not being met and gives business owners an opportunity to respond. Our article on the benefits of forecasting and budgeting explores how regular forecasting can support better decisions, identify risks and prepare businesses for future growth.
Turning profit into sustainable growth
Running short of cash does not necessarily mean a business is unsuccessful. In some cases, it can be a consequence of success happening faster than the business’s finances can support.
The important thing is to understand the difference between profit and available cash and plan accordingly. Working with a management accountant can help businesses understand their numbers, anticipate potential cash flow pressures and consider the most appropriate options. Where additional finance is needed, they can help advice on the right funding that supports what the business is trying to achieve, rather than relying on short-term solutions whenever cash becomes tight.
At Hayward Wright, our team, can help you understand what your numbers are telling you through management accounts, cash flow forecasting and practical business advice. By identifying potential challenges earlier, we can help you make informed decisions and build the financial foundations needed for growth.