The title is, of course, a play on the medical issue of high blood pressure which is usually undetectable until, yes…until it’s too late.
Without proper monitoring, cash flow problems can cause a similar fate to your business.
How it starts…
They usually start out as small problems – you don’t have quite enough money to meet payroll, or you need to exclude a few invoices in this week’s accounts payable run.
And these little problems are usually remedied with the next bank deposit or line of credit draw.
These minor problems can be rationalized away because sales have been very good these pasts few months and the profit and loss that your bookkeeper gave you shows a healthy profit.
But…my company is very profitable!
In general, there is an over-emphasis on profitability. The bank wants to see the last three years as profitable in order to renew or increase your business line of credit. The financial pages and the stock market are obsessed with profitability. Shareholders demand it.
So it is not surprising when I hear from clients that they don’t know why they have to pull money from their 401(k)’s or home equity to keep the business afloat even though they are very profitable.
Profit and cash flow are not the same thing!
Profit is defined as revenue minus expenses. Notice that I didn’t say cash received minus cash expended.
Revenue is determined when a sale occurs not when the cash is received. So, if you sell $100,000 worth of inventory toward the end of the month and give your customer 30 days to pay for the goods, this is where the disconnect between revenue and cash starts.
Expenses on the other hand are recorded when a sale occurs. So, in our $100,000 sale example, the company has the underlying cost of this sale and other overhead costs that were necessary to ship out this product. Let’s say that the total cost was $80,000. This leaves you with a nice 20% profit of $20,000.
Of this $80,000, let’s say that $40,000 is payroll that is paid weekly. And the rest of the cost is payable to a vendor that only gives you 30 days to pay.
As you can see from this simple example, while you are waiting for the full selling price of $100,000 from the customer you have already had to pay half of your cost in payroll early in that 30 day window after shipping the product.
What happens when that customer decides to take advantage of your eagerness to continue to sell to them and slows the payment by 5 or 10 days. That’s not really unusual. But for your company, that is the start of your cash flow problems.
Stephen R. Hartfield, CPA
40+ years of helping businesses be profitable and solvent.
This is the first in a series of posts that will help you better understand how cash flow should be your number one priority.