Believe it or not, profitable businesses can go broke!

There is a significant difference between profit and cash flow and most new business owners find this out the hard way: “I am profitable, but I have no money”.

With proper monthly reporting and regular financial reviews, it often becomes very clear that business profits and the original injection of equity capital have unconsciously been “re-invested” in inventory and debtors. This explains any discrepancy between profit and cash – “profits” have been diverted to investment in working capital assets (inventory and debtors).

The start-up phase of a business is the most demanding in terms of capital funding requirements, and the first two years in the life of any business is often the most problematic in terms of cash flow management.  To avoid any surprises in the working capital requirements of a business, there is value in putting together a cash flow forecast at the beginning of each financial year.  This should form part of the budget and be updated daily.  A few minutes a day will allow better cash flow management and will identify any upcoming blips.  These can then be planned for in advance and managed effectively, rather than causing a panic at the time the issue arises.

A disciplined approach to financial management, including cash flow forecasting, will also provide comfort to business bankers.  It demonstrates your understanding of financial performance.  Monthly financial results with reviews, and daily cash flow management processes, provide a proactive and planned approach to funding. Provision of these is a good basis for creating long term and durable banking relationships.  Far preferable to the urgent phone call requesting an overdraft extension because something unexpected has crept up through a lack of systems and processes around trading and cash flow!

In summary, it is critical that all businesses have access to accounting systems that allow the production of timely, monthly, financial results for ongoing analysis.  This, together with a system that allows monitoring of daily and projected cash flows, supported by appropriate funding facilities, will provide all businesses with a strong base from which to prosper and grow with confidence.

Steve Wilkinson, The Alternative Board Christchurch and North Canterbury

Blog Cash Flow Management