What to do if profit is high but cash flow is low

Strong profit does not necessarily mean a healthy business, and this can be reflected in cash flow. There’s nothing more frustrating for a business owner than having your accountant tell you that you’re making strong profits – but you are struggling each day to pay bills. Overdue bills accrue and you are spending valuable time trying to work out why? It is a common misconception that a strong profit always means a healthy business and strong cash flows. In this blog we will explore the top three reasons that your cash flow may struggle, even when you’re producing strong bottom lines.

An improvement in working capital equals an improvement in cash flow. Working capital is the cash a business uses for its day-to-day trading activities. There are three main components that can be addressed when you’re looking to improve your working capital, and in turn your cash flow; these are trade creditors, trade debtors and inventory.

Take full advantage of credit being offered to you (carefully do so of course). At the same time keep low the cash held for debtors and inventory. Trade debtors and inventory should also be controlled to ensure cash is not tied up in these items. The best ways to control debtors include continually following up on invoices owing and troubleshooting issues that suppliers are having  paying invoices. Time allocated in this area of your business can be very rewarding, particularly in advancing good customer relations while managing cash on hand. For inventory, do not ‘over order’ stock, but still ensure you have enough available to carry out your day-to-day activities. This may mean putting careful thought to planning, but at the same time you will be streamlining business efficiency and being rewarded for doing so.

On the other hand, you should also look to take advantage of the full credit terms your creditors are offering to you. Delaying payment to the end of your credit terms will also free up cash flow which can be used in other areas of the business. However it is also important to maintain a strong relationship with your creditors, so running regular reports to ensure you haven’t exceeded any credit terms is also recommended.

We’ve all heard the well-known cliché that “The Only Two Guarantees In Life Are Death And Taxes”, and there are reasons for this. Tax payments should never catch a business owner by surprise. Tax payments are not included in the profit figure of the business, and need to be paid after profit is calculated.

The impact of future tax instalments needs to be well understood. Both GST and income tax are significant impositions on a business and managing them is a critical element in cash flow. We recommend using a rolling forecast of future obligations to better budget for these payments. You may also consider opening a separate bank account solely for the purpose of putting money away for tax.

Property, credit card and all other repayments must be given careful attention, but another ‘loan’ that is often neglected is ‘owner drawings’ – repaying the owner. Payments to the owner sit outside the profit figure of the business and consume a lot of the business’ cash flow. Therefore, when thinking about your next big purchase, don’t forget about the current debt that the business needs to service.