Author Archives: Fiona McKenzie

Cash flow, profit and your growing business

In my last article I illustrated why a company with steady profitable trading may still need an overdraft i.e. have profits but no cash. In this article I’ll illustrate why a rapidly growing company which is increasing its sales substantially can have an even greater cash flow problem!

Expanding Ltd has the same costs profile, sales margins and credit periods as Stable Ltd here. The only difference is that its sales and consequent profits are increasing substantially each month. As with Stable simplified timings are:

  • Expenses e.g. stock, salary costs are paid for at the end of the month a sale is made
  • Sales invoices are issued at that month-end with a strict 40 day credit period
  • Profit is a steady  25% of sales
  • The period begins with no cash in the bank

Expanding Ltd.’s increasing sales and profits are illustrated by the graph and table below:



In six months Expanding Ltd earns a profit of £2,444, this is £944 more than Stable. However at the end of the period Expanding has a much higher overdraft owing the bank £1,706 more than Stable!  See the cash profile below:



Looking over a 12 month period (not illustrated) Expanding earns a profit of more than £11,500 but has an overdraft of £6,200. So while Stable earns annual profits of £3,000 and has a healthy cash position at year-end Expanding is nearly three times as profitable but still significantly overdrawn.

The reason Expanding has far less cash can be seen in the timing differences; costs are paid several months ahead of receiving revenues. Because sales are increasing the costs increase before increased revenues are received. This leads to the requirement for a much larger overdraft.

The above illustrates a phenomenon termed ‘overtrading’. If a business has not planned its cash flow it can find that despite being very profitable it has run out of funding in the form of loans or overdrafts and for that reason can no longer continue to trade. Profitable businesses can go bust purely because of lack of cash.

If you plan to expand your business substantially do not assume that profitability will result in sufficient cash. There are a number of strategies to ensure that cash flow does not cause problems but first you must be aware and plan for cash as well as profit.

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Why profit may not equal cash in the bank

One of the most frequent questions I have been asked by owners of profitable businesses is “where is the cash?” They’ve been trading profitably for a long period but still have a large overdraft! Why?

Some timing differences are understood, expenses are generally incurred before the sales can be made. However there is often an additional lag because accounts record the sales invoiced and expenses incurred in a given period. That this measure of trading does not equate to cash movements can best be illustrated graphically.

A very simplified example shows Stable Ltd

  • Expenses e.g. stock, salary costs are paid for at the end of the month a sale is made
  • Sales invoices are issued at month-end with a strict 40 day credit period
  • The period begins with no cash in the bank

Stable Ltd is making a steady profit (green bars) as shown by the graph and table below:

Graph Income ,Expenses, Profit

 So – steady profits – no problem? Until we look at the cash flow as illustrated in the graph below:  


Stables’ cash flows are negative. The green bars show overdraft (negative cash) increasing then only gradually diminishing despite the (positive) profit. Stable raises and records the sales invoices on 31 January (£1,000) but does not receive the cash until early March. Meanwhile costs such as salaries and stock have to be paid in January.

Although not illustrated, despite having accumulated profits of £2,000, Stable does not have positive cash until September at which point the balance is £250.

It’s important then, to understand and model your cash timings. In the example above, if Stable had an overdraft limit of £750, despite trading profitably it would soon have faced difficulties.

What’s in a number?

I’m a finance professional but would be the first to admit the possibility that numbers can be meaningless and maybe boring. Numbers should be able to give you essential (and interesting) information about your business. The crucial issue is context. So if you’ve ever looked at accounting information and thought ‘so what?’ you are not alone.   

Asleep on the job

Consider this…

The number is 50,000!

??? (yawn/blank look)

It’s Acorn Ltd’s profit for the year!

Is that good?

More information:-

Acorn had sales in the year of £20 million.

Not sounding so good?

More Information:-

Last year Acorn Ltd had a flood at its main premises and made a loss for that year of £1 million.

Forecast loss for this year was £200,000

Not sounding so bad?

More information:-

Most other companies in the same industry made losses in the year.

Now sounding like a better result?

By drilling down to the figures in the context  of what you know about the business and comparing to previous periods, budgets and forecasts,  you obtain information not just about how the business has performed but indications of relevant action points for the future.  

The story

And so we get to the story

Acorn made £250k more than forecast. Because:-

  • Sales had increased by £500K. This was due partly to new sales generated by the newly recruited sales manager. Customer feedback also suggests that Acorn products are considered more reliable than competitors.
  • Product costs had increased by £200k. This was due to the price increase of a component. Engineering consider that this component is of superior quality and more reliable than components used by rivals.
  • Sales manager’s salary was £10k more than planned due to a bonus paid because of sales generation beyond target.
  • Planned training and recruitment costs of £40k had been postponed for 3 months.

Action points

  • Management were preparing to switch to a cheaper component but since the more expensive products provides a competitive advantage will retain. Consider sales pricing increase to compensate for increased cost.
  • Sales Manager was on a temporary contract and will now be offered a permanent contract.
  • Budget for the additional £40k costs which will occur in the next period.

    Coffee Break
    Well earned break


For your business figures to be useful they need to have context. This can be provided by comparing your figures to others in the business (benchmark), previous periods performance, or/and expectations (budgets or forecasts). Although this comparison may in itself provide some interest, in order to be meaningful for directing the business you should also be able to further analyse the figures so as to understand the business detail and respond to the information consequently obtained.