Cash flow versus profit – Which matters more to an SME?

While profit can be seen as the main indicator of business health, the importance of cash flow is often overlooked.

You could be making money on paper but still be broke, unable to meet bill payments and even on the brink of insolvency.

This balancing act is especially important for SMEs.

The profit & cash flow conundrum

Of course, profit is an essential component of a successful business, but it does not provide the complete picture.

What if a business is making more money than it spends but can’t afford to pay bills or taxes to HMRC? Profit alone can’t be trusted.

Enter cash flow.

This metric focuses on the flow of money in and out of the business bank account, reflected in a cash flow statement.

If a cash flow statement is positive, the business has enough liquidity to cover wages, suppliers and tax liabilities, amongst other expenses.

So, even a profitable business can have a negative cash flow if money in becomes delayed or costs are paid up front, for example.

How could this happen?

Imagine a company called ABC Trading invoiced £15,000 for a project in March but they were due to get paid in August.

If you were to solely consider profit, the business has just been made £15,000 richer.

However, in the four months until payment, ABC Trading must cover payroll, rent and the costs of delivering the project.

Now imagine that this happened several times with projects for different clients.

With poor cash flow management, this squeeze might push ABC Trading to the verge of insolvency.

Why does this hit SMEs harder?

Maintaining profitability and a positive cash flow can be harder for SMEs.

A lot of cash flow problems faced are not necessarily the fault of the business.

They can result from late-paying customers, rising industry costs or even administrative errors.

Typically, smaller companies have thin cash reserves, a smaller client base and fixed costs that are proportionately higher than bigger operations.

Also, it isn’t unheard of for small business owners to act as guarantors on loans or leases, meaning poor cash flow management can also impact personal finances.

This is why SMEs feel the pressure much more.

An accountant can help to relieve the strain by protecting small business owners from cash flow crises and personal financial risk.

While smaller operations are unlikely to have the resources for an in-house accountancy team, outsourcing can give them the benefits without additional costs.

Five cash-flow management techniques

Considering how important cash flow is for day-to-day operations and business success, here are some strategies to ensure it remains positive.

1. Monitor and forecast cash flow regularly – create rolling cash-flow forecasts to predict future income and avoid cash shortages.
2. Improve payment terms – chase invoices consistently and offer multiple payment options to clients.
3. Keep a cash buffer – costs can arise when you aren’t expecting them, so cash reserves can prevent financial strain.
4. Funding and grants – funding and grants can inject working capital into an SME without adding repayment liabilities or watering down business ownership.
5. Be strategic with spending – explore whether it is possible to negotiate flexible payment terms with suppliers. Prioritise essential expenses whilst delaying those that are non-critical.

How can we help?

While a month of poor profit is bad, it isn’t nearly as bad as a month of poor cash flow.

Luckily, these problems can be mitigated by careful financial planning, so you can flag problems before they cause damage.

Our team can help you out with creating cash flow forecasts, tax plans and financial planning to make sure you can always meet obligations.

Get in touch today to become more confident with cash flow.