Why a profitable small business still struggles with cash flow.

Jim Smith is an entrepreneur and has been in business for 2 years now and according to his income statement his business is profitable.

However, when it’s time to pay the bills, Jim is always feeling broke and struggles to make payments or payroll.  This leaves Jim feeling frustrated and he doesn’t understand why this is happening if he is making money.  Jim finds himself asking if this is the way things are meant to be as an entrepreneur.

Well I am happy to say that this is not the case and here are some important things to remember when you have a small business or any business for that matter when it comes to cash flow and income statements:

Show me the money, or at least where it is at!

On paper your business is making money, so why are you dealing with frequent cash flow challenges? It’s simple. You spend your hard-earned cash on all sorts of things that don’t show up as an expense on your year-end income statement or tax return. This includes things like the following:

Loan Payments

The interest you pay on bank loans will always appear on your year-end income statements or tax return. What doesn’t show is the amount of loan principle you pay to the bank. So, for example, if you have a monthly payment of $250 ($50 in interest and $200 in loan principle), the only thing that will show up as a business expense is the $50. Over the course of the year that adds up to $2,400 and that’s using an example of a small loan payment.

Repayment of Credit card debt carried over from last year 

Payments you make on long-term credit card debt are treated much the same way as loan payments. Only the interest appears as an expense.

Money spent on new equipment 

Money you spend on the purchase of new equipment for your business (things like computers, POS terminals, furniture, new or used vehicles etc.) cannot all be claimed as a tax deductible expense in the year of purchase. The government forces us to amortize these costs over many years. So, the bottom line is in the first year, most of what you spend on capital purchases will not show up as an expense on your income statement.

Income taxes payable 

If your business isn’t incorporated, income taxes payable will never make it to your income statement. For an incorporated business, this amount should appear on your year-end adjusted income statement (you may not see it on an income statement generated internally).

Increases (or decreases) in inventory

If your business carries inventory, any increase (or decrease) in the total value of the inventory will have an impact on your cash. This variance doesn’t show as an expense. Hint: If you have inventory and you’re facing serious cash flow issues, check to see if you have too much inventory on hand. Unless your sales are up dramatically, you never want to see the total value of your inventory increase on a year over year basis.

Changes in Accounts Receivables 

If your business sells on credit, any increase (or decrease) in the total value of your accounts receivables will have an impact on your cash. This variance doesn’t show as an expense. Hint: If you sell on credit and you’re facing cash flow issues, check to see how much cash you have tied up in receivables. Unless your sales are up dramatically you never want to see the total value of your receivables increase on a year over year basis.

So, now that you have a better understanding of where your sales dollars are going, know your true expenses for the business, that way you will know how much money your business needs to bring in each month to cover the bills.

It is not easy but now that you know the main challenge it is time to work on overcoming it.

It is important that you figure out the minimum net profit your business needs to make sure that you can pay all of your monthly expenses on a timely basis.

If you don’t know what that number is, then it’s doubtful that you’ll ever get there.

As you will have figured out by now if you are reading this article, the information found on your income statement won’t tell you what that minimum net profit goal needs to be month to month.

So, you need to work on understanding your sales cycles and month revenue so that you can better understand the impact that these have on the success of a business and increasing your cash flow.

By Denise Alison