Profit and Cash are two very different babies in the business world. Businesses could be making a profit and yet may not be doing well and can get into financial trouble. A lot of times business owners fail to understand the importance of cash in the business. Here is a very simple example illustrating the profit and cash conundrum for an entrepreneur starting up without thinking about cash flow.
So today after a long while, I go to Yoga class and I notice 3 people in the class with the same kind of water bottle. Mind you this is a special water bottle, it has yoga creed written on it and it is modern, chic, big and has a special straw that makes it easy for me to gulp big sips of water (hey,I am making this up, so let’s run with it ok!), I am totally intrigued.
Now, the entrepreneurial side of me wakes up and I decide to find out more about this over the top, funky bottle. I do my research and this is what I find out. I am able to sell the bottles to retail stores for $20 and if I source the bottle from China, it costs me $10 to manufacture it with all the bells and whistles, ship it and get it out to the retailers. So I am essentially making $10 a bottle. Wow! Happy dance here….$10 per bottle is a mighty nice profit.
Lets’s get to work!
So, I decide to get the ball rolling. I work on it day and night, get my savings together- let’s say $40K and get huge consignments delivered to the stores. They give me Net 90 terms. The product is still new, they want to see how it goes and anyways in the business, Net terms are natural. Great! I just sold $40K of product and made a profit of $40K. Awesome! The bottles are flying off the shelves! My risk totally worked out. The retailers are calling for more pieces. I need to get to my manufacturer to get double the quantity now. But wait, i don’t have the money.
Profit without cash
We made a profit – a whole $40K but as a start-up and having used up all my savings, I have no cash to go out and get more bottles. I don’t even have enough to pay my electricity or internet. Whoa, what just happened?
That’s why making a profit versus actually having the cash can ultimately make or break the best of the best. When you are first starting out it is imperative to understand this concept to keep in mind that all the sales in the world will not help you if you cannot collect on the money that’s owed in a timely manner. Cash keeps the company alive and cash flow is a critical measure of its financial health. It is important to have a realistic cash flow plan to help you plan and overcome the pitfalls.
As an entrepreneur we wear many hats, all the C’s for sure – CEO,CFO,COO, Cleaner, Caretaker, etc. etc. Looking at your financial statements is imperative. A keen eye will give you the solution. For example, if you are making a profit but don’t have cash to grow (like our example above), you need someone who can help you find the finances. On the other hand if you have cash but are not making a profit, you need to find a way to bring your costs down.
Mitigate with Accounts Receivable Financing
One of the ways to overcome this particular situation is by Accounts Receivable Financing. Accounts Receivable Financing provides cash funding based on the company’s outstanding accounts receivables. Lenders extend short term credit based on the accounts receivables. It is a relatively lengthy process, but can help a business in this situation. Read more about Accounts Receivable Financing in our blog.
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