Anyone who has run a business knows there is a big difference between profit and cash. Profit is an accounting term while cash is what you can actually spend. You need cash to run your business, however without profits you cannot get excess cash. While the two terms are related, they do not always happen at the same time. After all, it is not unheard of to see broke profitable businesses.
So why do broke profitable businesses exist?
Below are four reasons why cashless, profitable businesses exist:
1) Too much accounts receivable: Profit is your revenue minus your expenses. Revenue is money you get from operating your business. Revenue often comes in the form of cash but not all cash that flows in the business is revenue. Sometimes your customer engages in a transaction with you but promises to pay later. In that case, you have revenue with no cash.
2) Selling inventory too slow: If your inventory is moving slow, you will not be able to generate cash fast enough from your inventory purchases. This inventory eats up cash but does not show as an expense till you sell the inventory. So, in that case, your business could be showing it is profitable but you have too much cash tied up in inventory.
3) Having too many loans: When you have too many loans, cash that should be used to run the business will go to the lenders. While your business may be looking profitable, there will be less cash to support future growth.
4) Taking too much money out of the business for personal use: It is okay to reward yourself for the risks you take in your business. But doing this in a non-systematic way could be bad for your business. This is because you are not purposely about how much you take out. You could end up taking out too much leaving your business starved for cash. Your business might be profitable but yet has very little cash to support it.
Take a look at this video, to see how profitability and liquidity are connected.
To grow and manage a business, you need both profit and cash at the same time. Maintaining the balance between cash and profits is essential for long term survival.
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