Positive Cash Flow Vs. Profit

Generally, when the business is profitable, it also has positive cash flow.

Sometimes, a business can have positive cash flow and not be profitable OR have negative cash flow despite being profitable.

How is this possible?

Let’s look at an example of a positive cash flow business.

Business A – Positive Cash Flow And Profitable

This business has an opening bank balance of £10k.

The business collects £50k from clients in a month.

Then, the business pays £30k to vendors.

Month-end closing balance = £10k+50k-30k = £30k, which means positive cash flow.

Business B – Positive Cash Flow But Not Profitable

This business also has an opening bank balance of £10k.

It collects only £10k, the same amount for customer sales, and the owner puts £20k into the business.

The business also pays £30k to vendors.

Month-end closing balance = £10k+£10k+20k-£30 k= £10k, which is still cash flow positive.

However, the problem is that this business is not profitable as revenue is less than costs and expenses. This business survives only because the owner is funding it.

Business C – Negative Operating Cash Flow But Positive Net Income

Business C also has an opening bank balance of £10k.

The business collects only £10k from customers despite making sales of £50k in the month, and the owner does not put £20k into the business, like in business B.

Then, the business needs to pay £30k to vendors, but the business has negative cash flow despite being profitable.

Why did the business only collect £10k from customers when sales were £50k?

Because the payments aren’t due yet.

So, the business may be profitable and still have cash flow problems.

In this case, the month-end closing balance = £10k+10k-30k = – £10k (Negative cash flow)

If the term negative cash flow is new to you, I explain it below.

Positive Cash Flow vs Negative Cash Flow

A business with negative cash flow means more money goes out than what comes in.

Again, this could be just like the example we used above.

Just because more money goes out than coming in doesn’t mean you are making a net loss. If you have to pay creditors before you collect the cash from clients, the business will have negative cash flow even though the business may be profitable.

So, what could cause negative cash flow?

It can happen because of the following reasons.

• Business is not profitable.
• Business operations are not run efficiently and are costing the business more manpower
• Uncollected Trade receivables
• Timing of cash outflows.

It reminds me of one of my clients selling luxury goods who pay quarterly VAT.

As the VAT amount was paid on 5th Nov 2023, 2 days before the VAT payment due date of £235k, the business also invested in 3D virtual reality technology in the same month, which was £102k. As the business cash outflow exceeded the cash inflow for the month of November 2023, the closing cash balance cash position was negative.

You can imagine how stressed the business owner was at the time.

What are some ways to achieve positive cash flow?

In order to get positive cash flow, match cash outflow according to cash inflow. Set up a minimum cash flow balance to cover rainy days, be financially disciplined, and spend while staying above that minimum cash flow balance you set.

For example, instead of collecting the cash of £100k and spending £110k, which leaves you with a negative cash balance of £10k, set a target to have a positive £10k cash balance. Based on the £100k cash collection, only spend £90k and still have a positive £10k balance.

Do it by becoming disciplined and not spending an extra £20k in this period and spending in the next period, where you don’t have to pay other costs.

1. Avoid Fraud Or Theft

Unexplained spending could be due to an employee stealing from your business. Tony Robbins, who has coached everyone from Bill Clinton and Oprah Winfrey to Mother Teresa and Nelson Mandela, experienced this early in his career. While he was on the road doing seminars and making money for the business, a trusted employee was siphoning off the money by forging his signature. He only knew of it later, when more than half a million dollars was gone from his business.

Prevent fraud and theft by working with external auditors, installing security cameras, separating duties, investing in inventory tracking systems, spending, and access to data.

2. Avoid Overpaying Vendors

To avoid overpaying vendors, establish a monthly supplier payment run process where at least two people cross-check and approve the payments.

3. Control Large Cash Outflows

This could be due to spending covering equipment costs for a large project. It might be because you are expanding and need to buy or rent property nationwide or hire people worldwide. You may also be bidding for a project in the public sector and need to pay upfront before being awarded the contract.

4. An Actual Loss

This may happen if you make a product far more than you can sell. You may find that you added a new product to your line and the marketing campaign costs more than you expected, and hence, it exploded your budget way beyond what you planned.

A prolonged negative cash flow can ring alarm bells with investors. They expect you to spend money and invest in the business, but they also wish to balance the books eventually.

Negative cash flow is part and parcel of new exciting businesses such as Tesla and Uber, but they are finally addressing their negative cash flow.

Your business doesn’t have deep pockets like them and needs to address it sooner. So watch out for profitability, stability, and sustainability, which you can have with constant positive cash flow.

5. Improve Gross Profit Margin across product lines

From what I have seen and experienced reviewing my client’s financial statements, gross profit margin is the key driver of the business. If the business doesn’t have a good gross profit margin, net income will be significantly less than sales revenue growth. Ultimately, it will have an impact on the business’s cash balance.

6. Establish a payment run process to make timely payments for accounts payable

One of the good processes I establish when I work with my clients as their trusted accountant is to set up a payment run to pay the creditors. It streamlines supply chain management by paying them on a specific day of the month.

How?

Because there is a clear payment pattern for them, and the suppliers are easy to manage. At times, you can communicate with them if you are not able to pay them in full and only part pay to ensure your business remains cash flow positive.

7. Regularly review accounts receivable ledger to collect payments from invoices on time

You need to review accounts receivable on a regular basis. Ideally, every two weeks, your invoices are paid on time. Accounting software can help you to provide a list of clients or customers who haven’t paid you yet. This list of customers who haven’t paid are called debtors.

You can find this report like this here.

Going through the debtor’s report will ensure you collect the cash as it falls due.

8. Pay attention to cash flow from investing activities

Although most cash is generated from operating activities, do not ignore cash flow from investing activities. You need to be strategic about investing in cash flow.

What do I mean by that?

Investing cash flow in the right areas of the business that need attention or solve bottlenecks in your business.

For example, one of my clients is a marketing agency specializing in tourism.

Her biggest roadblock was she had to do most of the work, even though she was the business owner.

How do you fix this?

By investing in a new employee to write articles across her client base. She just did that.

As a result, she had more capacity to work with more clients, and her business and cash flow grew in the subsequent months.

9. Pay attention to cash flow from financing activities

You also need to pay attention to cash flow from financing activities to remain cash flow positive. Along with cash flow from operating activities and investing, it is one of three types of cash flow if you want to improve cash position further.

There are a few things you can do.

You can take out a loan from the bank. Although you have a debt on your balance sheet, you have money in your bank account as an asset.

This will help you ensure your business has positive cash to fund your business growth while helping you navigate current money worries.

If you do not want to go down the route of taking out a loan, you can consider an invoice factoring.

Invoice factoring is a service offered by a factoring company that pays you upfront cash around 80% value of the sales invoice. They collect the payment from your customer, and depending on your agreement, they pay you the balance, deducting their commission.

One of my clients who sells women’s clothes does this effectively. She prepares cash flow forecasting statements to determine if she will experience a cash flow shortage while she has outstanding invoices.

Then, if she is going to experience a cash flow gap, then she goes for invoice factoring to ensure she has sufficient cash to pay her staff salaries and other financial obligations.

10. Consider liquidating cash equivalents

You might not have enough money in the bank account, but if you have cash equivalents, you can liquidate them easily and generate cash.

Things like inventory, unpaid sales invoices, shares, etc. These are called cash and cash equivalents. When you sell these liquid assets, you can maintain a healthy cash balance by maintaining positive cash flow.

Maybe at this stage, you are unsure which strategy you should implement right now. if so, I have a bonus tip for you.

Here’s what I believe.