I get a lot of questions about managing cash flow, so I want to write a bit about what cash flow is and isn’t, and how to distinguish between a cash flow problem and a (more serious) problem with profitability.
The terms cash flow and cash flow problem get thrown around a lot, but I find a lot of folks aren’t clear on exactly what they mean when they use the term. Cash flow problems are temporary moments of not having cash when you need it. These temporary problems usually have a clear cause, like a client unexpectedly pays late or you spill yesterday’s afternoon work beer all over your Macbook and have to buy a new one. The cash flow problem should be a one payroll, or one month situation: temporary by definition.
If cash flow problems are ongoing, they’re not really cash flow problems, they’re symptoms of a profit problem. A profit problem is when your business is not profitable enough on an ongoing basis, the business’s finances frequently feel tight, and you’re juggling money to make ends meet multiple months in a row.
Temporary cash flow issues are solved via drawing on the businesses’ savings account or a line of credit, both of which you use for short term coverage — say, a single payroll — and then pay back within a short period of time. When used this way, a savings account is sort of like a self-generated LOC in that you also want to be able to replenish it in short order.
If it’s actually a profitability problem, then managing cash flow won’t help you, because you need to fix the underlying profit problem. You can try to “manage” cash flow all you want, but if you’re not profitable enough there just won’t be enough cash to manage, period.
A few tricky rules to remember:
- You can be profitable, or look profitable, and still run into cash flow problems. Big expenses or late paying customers or clients can cause a temporary bottleneck.
- You can be profitable and have an ongoing issues with late client payments, which cause ongoing financial problems, which means you have a relationship problem to fix. The cash tightness is a symptom.
- You can be profitable and not be profitable enough. Most businesses, run with under 10% profit margin will feel tight frequently. It’s not a bad idea to recalibrate your brain to consider 10% profit break even.
- If you’re not looking at your Balance Sheet, you’re more likely to assume you’re profitable when you’re not. LLC owners need to be especially careful here as owner salaries and taxes end up on the balance sheet. A sexy looking Net Profit on the P&L doesn’t always translate to cash in the bank — there’s a lot of math that happens on the balance sheet that involves real cash.
So, if your finances feel tight or confusing, check if it’s a temporary issue. Usually you’ll be able to put your finger on a concrete cause.
If you can’t name the cause, then chances are you’re going to have to look deeper under the hood and figure out your profit.