Will Limkemann
Business Advisor
The Constant Entrepreneur:
Advice for Running a Productive Business
Mistaking Profit for Cash Flow
How is it that some small businesses show a profit on their income statements, but can not pay their bills? I have encountered this situation several times recently with small and growing companies. On the income statement the business seems healthy, but when the balance sheet is reviewed, the real story emerges.
A most common reason for no cash is that customers have been invoiced but not yet paid. I never understand why a business is willing to wait 45 or 60 days for customers to pay, yet will pay their own vendors within 10 days! The income statement may show a profit but the bank account tells a different story.
Sometimes the error is simply the result of faulty accounting. A worst case example might be this. The business has borrowed $500,000 for equipment and is paying down the loan at, say, $10,000 per month. A portion of the payment needs to be charged as an expense, the remainder is applied againt the principal (a liability account on the balance sheet). The sloppy bookkeeper will apply the entire amount againt the principal, showing no expense.
The other faulty accounting scenario will be that the payment is properly applied, but the equipment is not properly depreciated. A depreciation amount should appear as an expense each month, thus reducing the profit. In either of these scenarios, cash has gone out depleting the bank account while the company is showing an inflated profit.
Another situation occurs when there is rapid growth. New equipment is purchased, and inventory is put in place in anticipation of future large billings. Both of these may require a cash outlay for items that will be put on the balance sheet but will not be immediately reflected in the income statement. Thus a profit may be shown, but there is no money in the bank!
Cash is king! Whatever the income statement shows, what really matters is what is reflected on the balance sheet. The simple rule of thumbe is: are current assets (cash and accounts receivable) enough to pay off current liabilities (accounts payable and other current debt)? If not, there will be cash flow problems.
Will Limkemann
Limkemann Business Advisors
440-871-0976
www.neobizadvisor.com
will@limkemann.net
September 14th, 2008 at 6:42 pm
Say it, brother!
Ain’t nothin’ like greenbacks when folks sayin’ they wants to get paid. Business be all about cash. Cash goes running by you like a little creek, comes from there, goes over yonder. And you sitting there with a plastic cup scooping out all you can.
Never be ashamed to give a discount for cash (not checks, not credit cards: cash).
And never pay a creditor who can’t put you out of business until you pay the creditors who can.
My ol’ law profs at Oxford said, “Fast Eddie,” yeah, they called me that, “you go out there, first thing you buy before a desk or a telephone (which were rare in the 17th century and even if you had one you couldn’t connect it to anything much) or anything else is the head of a barrel. Make a little table top of it. Then you point that out to buyers and say, ‘Put cash on that barrelhead.’ Folks with money will pay you now and respect you for asking. Folks without money will know you’re a chump and so won’t pay you even if they do get some money later.”
I sometimes say my worthless son in law, James, is King, but really, it’s Cash.