Why Profitable Businesses Still Face Cash Flow Problems

Profit Doesn’t Mean Cash: Why Successful Businesses Still Run Into Cash Flow Problems

By Anita Rasheva MAAT,  AD Accounting & Business Solutions Ltd

A business can be profitable on paper and still struggle to pay its bills.

It sounds contradictory, but it is one of the most common issues I see when working with business owners. A healthy profit figure does not necessarily mean there is the same amount of money sitting in the bank.

Understanding the difference between profit and cash flow can help business owners make better decisions, prepare for tax liabilities and avoid unpleasant surprises.

Profit and Cash Are Not the Same Thing

Your profit is broadly the income your business has earned less the expenses incurred in generating that income.

Cash flow, on the other hand, looks at the actual movement of money into and out of the business.

The two are connected, but they are not interchangeable.

For example, your accounts may show that you have made a £30,000 profit, but that does not mean you should expect to see £30,000 sitting in your bank account.

Some of your customers may not have paid you yet. You may have repaid loans, purchased equipment, paid VAT or withdrawn money from the company.

This is why looking at the bank balance alone rarely gives you the full picture of how your business is performing.

The Tax Bill That Catches Business Owners Out

Another common mistake is treating all the money in the business bank account as available to spend.

Depending on your business structure and circumstances, some of that money may ultimately need to cover Corporation Tax, VAT, PAYE or personal tax liabilities.

The problem often becomes apparent when a tax deadline approaches.

The business may have generated a good profit, but the money has already been spent or withdrawn.

This is why tax planning should happen throughout the year  not just when the accounts are due.

Dividends Need Proper Planning Too

For limited company directors, dividends can be another area where problems arise.

A dividend is not simply a transfer of money from the company bank account to the director.

The company must have sufficient distributable profits available to support the dividend.

Regular bookkeeping and up-to-date financial information therefore become particularly important when directors are taking money from their companies throughout the year.

Without knowing the company’s actual financial position, it can be difficult to know how much can safely be withdrawn.

Your Accounts Should Help You Make Decisions

Accounting should be about more than submitting figures to HMRC and Companies House once a year.

Good financial records can answer important questions while there is still time to act:

Is the business genuinely profitable?

Are your margins improving or declining?

How much should you be putting aside for tax?

Can the business afford a new employee or investment?

Are customers taking too long to pay?

Are you taking too much money out of the business?

Waiting until the year-end accounts are prepared can mean discovering a problem months after it started.

Small Habits Can Make a Big Difference

Business owners do not necessarily need complicated financial systems.

Keeping bookkeeping up to date, reviewing outstanding invoices, separating money for tax and regularly checking performance against expectations can make a significant difference.

Most importantly, speak to your accountant before making significant financial decisions rather than afterwards.

There are often more options available when advice is sought in advance.

Know Your Numbers Before They Become a Problem

Your year-end accounts tell you what has already happened.

Good financial management helps you decide what happens next.

Understanding the relationship between profit, cash flow and tax gives business owners much greater control over their companies  and can prevent a profitable business from unexpectedly finding itself short of cash.

Anita Rasheva MAAT
Founder, AD Accounting & Business Solutions Ltd