Why a Profitable Business Can Still Run Out of Cash

The income statement shows a profit. Customers are buying. Revenue has increased. Yet payroll approaches and the bank balance feels uncomfortably low.

The first task is to understand the timing of cash. A company can report earnings while money remains tied up in unpaid invoices or inventory. It can also have cash demands that do not appear as ordinary operating expenses in the same way, such as loan principal payments and equipment purchases.

Trace a sale all the way to the bank

Ask when the business spends money to deliver a sale and when the customer actually pays. The gap between those events determines how much funding the business needs while it waits.

Consider a hypothetical service company that pays staff weekly but collects customer invoices after 60 days. Winning more work may increase reported earnings while requiring the company to finance additional payroll before receiving payment.

Review receivables by age, customer and dispute status. An invoice due next week and one disputed for three months should not carry the same weight in a cash forecast.

Account for the demands outside operating profit

Build a list of debt principal payments, equipment commitments, tax payments, owner distributions and other cash obligations. Work with the accountant to connect those items to the financial statements without counting them twice.

An owner may look at annual profit and conclude that a distribution is affordable. The timing of that distribution can still leave the business short ahead of a seasonal purchase or a large payment.

Use a forecast short enough to act on

A rolling 13-week cash forecast is a useful management tool. It should show opening cash, expected receipts, planned payments and closing cash by week. It is a forecast, so assumptions should be visible and revised when circumstances change.

Separate dependable receipts from uncertain ones. If the plan requires several overdue customers to pay at once, show an alternative in which collections arrive later.

Assign someone responsibility for updating the forecast and explaining material differences between expected and actual cash. The value comes from the decisions it informs: collection priorities, purchasing, hiring, financing and distributions.

Examine growth before funding more of it

If each additional sale consumes cash for several weeks, growth can enlarge the funding gap. That may be manageable when margins, collections and financing support it. It becomes dangerous when the company treats rising sales as proof that liquidity will take care of itself.

The FDIC's Money Smart for Small Business includes cash flow management among its core business-education subjects.