Why Your Business Can Be Profitable and Still Run Out of Cash

It is one of the most confusing things a business owner can experience. The accounts show a profit. Customers are paying. Sales are growing. And yet there is nothing in the bank.

If that sounds familiar, you are not alone – and you have not necessarily done anything wrong. But it does mean something important is happening that deserves your full attention, because a profitable business that runs out of cash can fail just as surely as one that is losing money.

Here is what is going on, and what you can do about it.

Profit and Cash Are Not the Same Thing

This is the root of almost every cash flow surprise we see. Profit is an accounting concept. Cash is what sits in your bank account. The two are related, but they are not the same – and the gap between them is where businesses get into trouble.

Your profit and loss account tells you the difference between your income and your costs over a period of time. But it does not tell you when money changed hands. And the timing of money changing hands is everything.

You might invoice a customer in March and record the income in March. But if they pay in June, the cash does not arrive until June. In the meantime, you still have to pay your staff, your suppliers, your rent and your tax. That is a cash flow problem, even if your March accounts look perfectly healthy.

The Most Common Reasons Profitable Businesses Run Short

There is rarely one single cause. More often it is a combination of things quietly building up in the background.

• Slow-paying customers. If your payment terms are 30 days but customers are routinely taking 60 or 90, you are effectively lending them money. You might hear it called “funding their working capital”. You’re probably cheaper than an overdraft. Multiply that across several customers and the gap between profit and cash quickly becomes significant. Alternatively, this might just be the norm in your industry and just something you have to factor into your everyday operations.
  
  
• Paying suppliers faster than you collect from customers. If your suppliers want payment in 14 days and your customers take 60, you are always funding the gap. This is known as a working capital squeeze, and it gets worse as the business grows. It is not necessarily something you can control but it is still your problem.
  
  
• Holding too much stock or work-in-progress. Money tied up in raw materials, goods for sale or an unfinished service is not available to pay your bills. It will show on your balance sheet as an asset, but it cannot settle an invoice. And it doesn’t pay your mortgage.
  
  
• Seasonal patterns. Many businesses have strong and quiet periods. If your quiet period coincides with a tax payment or a large supplier invoice, the timing can be punishing — even if the year as a whole looks fine. If you have a relatively solid fixed cost base, then you are hit with a double whammy.
  
  
• Tax bills arriving all at once. Corporation Tax, VAT, PAYE, and sometimes payments on account for Self Assessment can create significant outflows that were not planned for in time. We see this regularly, and it is almost always avoidable with the right preparation. If you are paying last year’s tax bills from this year’s money, you are always going to feel (and you will be) poor.
  
  
• Investing in growth. Buying equipment, taking on more staff, moving premises, or landing a large new contract all cost money upfront. The profit from that investment might not arrive for months. That is not necessarily a problem, but it needs to be planned. Sole traders and partnerships are more likely to suffer the pain of taxable profits but cash re-invested. Trading through the right legal vehicle can be pivotal and the timing of your investments is critical.

Why It Gets Worse as You Grow

This is what catches many business owners completely off guard. It sounds obvious but a growing business needs more working capital, not less.

If you double your turnover, you will likely need to pay more suppliers, carry more stock, and fund more work-in-progress – all before the additional income arrives. If your business is growing quickly, cash can get tighter at exactly the moment things look most exciting.

We think of this as the growth trap. The profit is real. The opportunity is real. But without proper cash flow planning, success can actually create the conditions for a crisis.

What Good Cash Flow Management Actually Looks Like

The businesses that manage this well tend to do a few things consistently.

They forecast. Not just the profit and loss, but actual cash in and cash out, week by week and month by month. A good cash flow forecast does not need to be complicated, but it does need to be maintained and updated regularly. It should tell you, right now, what your bank balance is likely to look like in three months (minimum), and flag any pinch points early enough to do something about them.

They know their numbers. Not just the headline figures, but the detail. How long are customers taking to pay on average? How quickly are supplier invoices going out? What is tied up in stock or work-in-progress? These are not accounting questions; they are management questions. This does not mean that you should be doing your own bookkeeping. Not at all. The owner should be focusing on the output not the input.

They plan for tax. Corporation Tax, VAT, and payroll taxes are not surprises if you are working with a good accountant who keeps you informed. Setting aside money each month as part of your routine is a much more comfortable position than scrambling to find it with days to pay. Run your draft VAT return once a week and make sure that you put that money into a separate bank account. If you’re in Making Tax Digital, check your tax & NI estimate after you’ve filed your quarterly return and put that money into an interest-bearing account until your payment-on-account or balancing payment are due.

They have a relationship with their bank. If you ever do need a facility, whether an overdraft, an invoice finance arrangement, or a short-term loan, the time to arrange it is not when you are already in difficulty. Banks are significantly more willing to support businesses that are planning ahead than those that arrive with an urgent problem. And with that, choose your bank carefully. We have recently moved our own account to a bank where we have a real person that has a phone number and an email address we can get hold of them on. Accountants have a great network of contacts so use yours to find trusted service providers.

The Role of Your Accountant Here

A good accountant does not just prepare your year-end accounts. They help you understand what the numbers are telling you throughout the year – well before things become a problem.

At Composure, our bookkeepers and accountants work side by side. That means we are looking at your real-time figures, not just the annual snapshot. If we can see a cash flow pressure building, we would rather have that conversation now than after it has caused a problem. Our bookkeepers are frequently the first ones to know; they can see when the business has got overdue bills, and when the flow of money in has dried up.

We also help our clients plan for their tax bills far enough in advance that they are never a shock. Knowing what you owe and when, and having the cash set aside, is one of the most straightforward ways to protect your business. But it requires accurate, up-to-date bookkeeping and an accountant who is actively paying attention. When we declare dividends for our clients, we send them a corporation tax estimate so they can put that money aside. When we file our clients Making Tax Digital returns, we make sure they get the estimates tax & NI figure in our confirmation email.

Profitability Alone Is Not Enough

The goal is a business that is profitable and cash-rich, with enough visibility of the future to plan properly and enough of a buffer to absorb the unexpected. That does not happen by accident.

If you have ever found yourself surprised by a cash shortfall despite the business appearing to do well or if you have never really looked beyond the profit figure to understand what is actually driving your cash position, that is a good conversation to have.

We work closely with our clients throughout the year, not just at year-end. If you would like to understand your cash flow position more clearly or want to make sure you are planning properly for the months ahead, book a call with the team. We would love to help.

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