How can some SMEs become profitable but broke?

You might think that being profitable but broke is a paradox. If you are making money, it must be impossible to have none of it, right?

While this doesn’t make logical sense, SMEs can be both profitable and without the liquid funds to pay bills or meet obligations at the same time.

This predicament can hit SMEs with a high exposure to cash flow crises particularly hard.

Why profit ≠ financial health

Profit is a great measure for businesses to see if their operations are functioning as intended, but it does not provide a complete picture in isolation.

As an example, imagine a company called John Doe Distribution has invoiced £30,000 for a project in August and is due to be paid in December.

Looking just through the lens of profit, this company has a contract that will eventually land a £30,000 payday.

However, John Doe Distribution now has four months of payroll, rent and project delivery costs that must be paid before the money touches the account.

Now scale up this problem and apply it to several different clients with their own project costs. John Doe Distribution is no longer ‘quids in’ but might be nearing insolvency.

Cash flow is king

This is where cash flow comes into play.

Cash flow focuses on the flow of money in and out of the business bank account to evaluate whether there is enough liquidity to cover wages, supplier costs and tax liabilities.

If the balance sheet is negative and these obligations can’t be met, then the profitability of a business becomes irrelevant.

For SMEs, maintaining profitability and a positive cash flow can be trickier.

This is because a lot of cash flow problems faced are not necessarily the fault of the business, like late-paying customers, rising industry costs or bookkeeping errors.

SMEs typically have thinner cash reserves and proportionately higher operating costs, so they are more at risk of cash flow crises.

It is not uncommon for owners of smaller businesses to act as guarantors or collateral on loans or leases, making poor cash flow a personal problem as well.

Rules of thumb for boosting cash flow

Considering how important cash flow is, here are some strategies to ensure your business stays afloat:

1. Monitor and forecast cash flow regularly – Creating cash flow forecasts can predict future income and help your business avoid cash shortages.
2. Improve client payment plans – If a client is paying late, make sure to chase down invoices consistently and provide multiple payment options to ensure you are paid on time.
3. Keep a cash buffer – A cash reserve is important to overcome any unexpected costs and financial strains you might encounter.
4. Be strategic with spending – Building healthy relationships with suppliers can open doors to flexible payment plans if your business is struggling to pay on time. Essential expenses should be prioritised over those that are not needed immediately.
5. Funding and grants – Taking opportunities for funding and grants can inject working capital into an SME without adding repayment liabilities or watering down your business ownership.

Do you need an accountant?

Cash flow management is essential for SMEs and often a better immediate indicator of business success than profit.

Understanding that a poor month of profit is outweighed by a poor month of cash flow is crucial, allowing businesses to realign priorities.

Hiring an accountant for your company can provide services that improve cash flow and protect against any risks to personal finances.

While smaller operations may not have the resources to take on an accountant full-time, outsourcing gives the benefits without the additional costs.

Where we can help

If you find your business struggling to stay on top of cash flow, or you think you could benefit from better financial planning, you should speak to an accountant.

We offer a range of services to ensure you are prepared and aren’t caught in the lurch by cash squeezes and unexpected costs.

Whether it is creating a cash flow forecast or a detailed tax plan, we have got you covered.