Why Small Business Owners Need to Pay Attention to Cash Flow

Is it possible to be profitable and broke at the same time?

Sometimes my clients come to me and say something like this:

John, I don’t understand. Business is really good. We’re making great sales. Our accountant says we’re profitable. But we don’t have enough money – I’m not sure we can make our next payroll.

This situation is not uncommon.

A lot of owners are surprised to discover that they can be both profitable…and broke…at the same time.

Sometimes, this comes from a lack of margin.

But, often the problem is cash flow. More specifically: the cash gap.

There’s a famous saying that revenue is vanity, profit is sanity, and cash is king.

This explains the situation where business owners wonder how their P&L can say they’re profitable, and yet they don’t have enough money to make payroll. How is that possible?

And that’s because your P&L shows a theoretical or operational perspective of the business and it assumes that all of the assumptions are true.

But what the P&L doesn’t reflect is how much working capital you need.

The Cash Gap

A cash gap occurs when you make a sale, then pay out expenses like supplies or payroll before you receive payment.

It’s this gap that leaves you feeling broke.

On paper, you’re doing great because the future payment shows as a receivable.

But in reality, the money isn’t in your account yet, so you’re broke.

For example, let’s say you’re a contractor.

On day zero, you start a project to install a bathroom. You order parts and your team starts working.

A few days later, you need to make payroll.

Then you pay your parts supplier.

But your customer hasn’t paid the invoice yet.

This space here is called the cash gap or working capital.

What it means is you need to finance. You need to have enough money to be able to pay your suppliers and your team – while you wait under the terms that you’ve got with your customers to get paid.

This issue can get worse if your customers are overdue on their invoices – or you don’t have an accurate, up-to-date, clear accounts receivable system.

How to resolve cash flow issues

Here are some simple steps you can take to deal with cash gap issues.

1. Collect invoices on time.

Send invoices out promptly and follow up on late payments. It can feel uncomfortable to ask, but this is how you stay top of mind. If you’re not actively managing this and let it go too long, you may find that your customers no longer have the money to pay you.

2. Keep your records current.

Keep your books up to date. If you don’t have time, hire a bookkeeper.

3. Do a cashflow forecast.

Project your revenues out by 13 weeks so that you can plan ahead and see cash crunches before they arise.

4. Don’t manage your business by your bank account.

Just because you have a lot of money in the bank today doesn’t mean it’s a good idea to go out and buy a big piece of equipment. Be sure to budget how much money your business needs as a lubricant to keep on going.

5. Arrange an operating line of credit.

Credit can help provide the short term working capital you need, but don’t get addicted to it. Too many owners max out their lines of credit as a short term solution and then end up back in the same place.

Cash flow issues often come with growth

If your business is growing like crazy, your need for working capital increases.

This is why it’s so important to have good systems and procedures around managing your finances.

If you’d like some help with this – or any of the other problems that come with massive growth – it might be time for a business coach.

You can book 15 minutes on my calendar to talk about business coaching: Book a call with John