The vast majority of businesses, particularly those in their early stages, go bankrupt through lack of cash, not from lack of profits.
However, many business owners don’t truly understand the difference between having cash and having profit and that can be a costly mistake. The phrase ‘cash is king’ is often quoted in business articles when discussing failing businesses and although it may be a cliché, that doesn’t make it any less true. Businesses can usually carry on longer without profits than they can without cash.
Here’s a simple example. I buy £200 worth of goods from a supplier on 30 day credit terms, and then sell them onto my customer for £500 on 60 day credit terms. I have made a £300 profit – great- but I won’t be receiving any money for two months and have to pay my supplier within a month. I have a profit but no cash to either pay my supplier or buy the next lot of goods to sell.
Let’s say the credit terms were reversed so that within the month I have £500 in my bank account but don’t have to pay my supplier for another month. The profit amount is the same at £300, but I know have £500 cash in hand. Some owners will look at the cash and use that to judge on what they can withdraw from their business. But I still have the supplier to pay, and this doesn’t account for things like buying future stock or paying overheads or taxes outside of the individual transaction. If I spend the £500 I will be in trouble even though I am a profit making business.
It may be tempting to withdraw funds from your business as soon as you have them, but bear in mind that there will always be extra things that need paying for and it’s important to leave enough cash flow in your business not to cripple it’s flow – and it’s future.