Why can’t my profitable business pay its bills?

If your for-profit business is struggling to make ends meet, it’s not the only one. Many entrepreneurs mistakenly equate profit with cash flow, leading to current account deficits. The truth is that there are many reasons why these numbers may differ.

Fluctuations in working capital

Profits (or pre-tax income) are closely related to taxable income. Reported at the bottom of your company’s income statement, they are essentially the result of revenue earned minus operating expenses incurred in the accounting period. U.S. generally accepted accounting principles (GAAP) require companies to match costs and expenses to the period in which the related revenues are earned. It doesn’t necessarily matter when you pay for a product or service.

So inventory items that are in progress or completed but not yet sold cannot be deducted even if they have long been paid (or financed). The cost only goes to your income statement when an item is sold or used. Your inventory account has many cash outflows waiting to be posted.

Other working capital accounts such as receivables, accrued charges and payables also represent a difference between the timing of cash outflows and the reconciliation of costs with sales. As companies grow and prepare for rising future sales, they must invest more in working capital, which temporarily depletes cash.

Capital expenditures and financing transactions

However, working capital only tells part of the story. Your income statement also includes depreciation and amortization, which are non-cash expenses. And it excludes capital expenditures and financing, both of which affect your available cash.

To illustrate, suppose your company purchased a new device in 2022. The expanded amortization of bonuses and Section 179 allowances allowed your company to immediately deduct the purchase price of the device, reducing taxable income for 2022. After making a modest down payment, the remaining amount of the purchase was financed with debt so the actual cash outflow from the investment was minimal in 2022. Throughout 2023 your company made loan installments and the principal portion of these payments reduced the balance of the company’s current account, but not its profits.

Capital contributions, dividends and share repurchases

You can also associate profit and cash flow differences with equity accounts. For example, owners can pay dividends based on their personal financial needs, regardless of whether the business is profitable.

Dividends (or distributions) paid to owners decrease available cash, but they do not affect the profit reported on the company’s income statement. Similarly, additional capital contributions and share buybacks will enter the company’s current account without affecting earnings.

Efficient cash flow management

It is important for business owners to understand the key differences between profit and cash flow. Some growing, profitable companies will experience cash shortages. And some mature cash cows will have plenty of cash on hand despite moderate sales growth. If your business is facing a cash crisis, contact us for help devising strategies to improve cash flow. We can help your company pay its bills on time and find resources to seize value creation opportunities.

2023