Do Positive Profits Ensure Adequate Cash?

I was once introduced to a business owner that had a problem he could not grasp.  During our initial meeting, he could not understand why his company had little cash.  The net income of his company was positive, and in addition, he collected from his customers in advance.  This is a situation I have encountered regularly in various forms.   Why do some companies appear to be doing very well, yet have very little cash?  Below are two major reasons cash is short even when profits are good and the business is growing.

  • The Company is really not Profitable– In the above situation I described, upon further research, I discovered that the company was not profitable but was operating at a loss.  The Profit/Loss statement was incorrect.  This particular company carried a large inventory, and the inventory balance on the books was inaccurate.  It was overstated which caused profits to be artificially inflated.  This business owner was bleeding cash thinking his product sales were profitable.  A quick analysis showed that price increases were desperately needed to return to profitability and positive cash flow.  Accurate financials are absolutely critical to the survival of a company.
  • Rapid Growth is Devouring Cash– Sometimes a company has its products and services priced properly, internal processes are efficient, and the accrual based financials correctly reveal positive profit margins. The problem is that the company is growing so rapidly that working capital needs are exceeding the ability of the company to fund its growth.  It is very important that all companies, but especially rapidly growing companies, to forecast cash needs based on forecasted sales and average collection of credit accounts.  With this information, the company can communicate with its bankers and other liquidity providers to arrange for the lines of credit necessary to fund growth.

Never assume positive profits ensure adequate cash.  Make sure the financials are accurate and forecasts are constantly monitored.

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