Why Profitable Businesses Still Run Out of Cash
Published by Stephen Kamau Kinyanjui, CPA(K)
Profit and cash are not the same thing. Understanding the difference is one of the most important disciplines for any growing business.
One of the most confusing situations for a business owner is seeing profits in the financial statements while constantly struggling to meet payments.
The natural question becomes:
“If the business is profitable, where is the money?”
The answer is often found in working capital and cash-flow management.
Profit does not automatically mean cash
Accounting profit measures revenues earned against costs incurred during a period.
Cash flow measures the actual movement of money into and out of the business.
The two can move very differently.
Consider a company that makes a KSh 5 million sale on credit.
The income statement may recognise the revenue immediately.
But if the customer takes 90 days to pay, the business does not yet have the KSh 5 million in its bank account.
During those 90 days, the company may still need to pay employees, suppliers, rent, taxes and other operating costs.
The company can therefore look profitable while experiencing significant cash pressure.
Where does the cash go?
Several areas commonly absorb cash in growing businesses.
1. Receivables
When customers take longer to pay, more of the company’s cash becomes trapped in outstanding invoices.
Management should monitor:
• Debtor days
• Overdue receivables
• Customer payment behaviour
• Collection effectiveness
Increasing sales without strong collections can actually worsen liquidity.
2. Inventory
Retail, distribution and manufacturing businesses can have significant amounts of money tied up in stock.
Cash problems arise when:
• Stock is purchased faster than it sells.
• Slow-moving items accumulate.
• Excess inventory is held.
• Poor stock controls lead to losses.
• Product margins are insufficient.
Inventory sitting on shelves represents cash that cannot be used elsewhere.
3. Supplier payments
Supplier credit can support working capital, but consistently delaying suppliers beyond agreed terms may hide underlying cash-flow problems.
A business should distinguish between:
Strategic use of supplier terms
and
an inability to pay suppliers when due.
They are not the same thing.
4. Loan repayments
Loan principal repayments reduce cash but do not normally appear as an operating expense in the income statement.
A company can therefore report accounting profit while significant cash is being used to repay debt.
5. Capital expenditure
Vehicles, equipment, renovations, technology and expansion projects may require substantial cash investment.
These investments may create long-term value, but management still needs to understand how they affect short-term liquidity.
Managing cash requires forward visibility
Good cash management should not begin when the bank account becomes low.
Management needs a forward-looking cash-flow forecast that answers:
What cash do we expect to receive?
When will we receive it?
What payments are coming due?
Where might a funding gap arise?
What actions should we take before the gap occurs?
For many growing SMEs, a rolling 13-week cash-flow forecast can provide significantly better short-term visibility.
Profitability and cash must be managed together
A financially stronger business should understand both.
Management should monitor:
Profitability
Are we creating sufficient margins?
Working capital
How efficiently are receivables, inventory and suppliers being managed?
Liquidity
Can we meet obligations when they fall due?
Cash generation
Is the business converting accounting profit into actual cash?
A company does not survive because it reports profits.
It survives because it can meet its obligations when they fall due.
At Scaybiz Services, we help businesses strengthen cash-flow visibility, working-capital
management, financial reporting and management decision-making.
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