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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