Where has all my profit gone?

If I'd made that much profit, I'd have more money in the bank, wouldn't I?, the client said, surveying the impressively profitable accounts laid before him.

Well not necessarily, replied the accountant nervously as he began to explain the reasons. “Some of the profit you took out as dividends, you had to pay tax of course, but most of your profit is financing the amounts owed to you by customers”. The client looked perplexed. “And then you have spent quite a bit buying new equipment and repaying the loan you took out when the business started.

“So I've made all this profit and yet there's nothing left for me” said the client as his head sunk into his hands. “That's one way of looking at it but it won't be like this forever. If you stop expanding quite so much, then you will start generating cash soon. You do need to keep an eye on your debtors though and manage your growth a bit better or you could get sucked in to some pretty nasty cash flow problems.”

Understanding the link between profit and cash flow is crucial if an expanding business is to survive what may be a roller coaster in its first few years. It is easy to get drawn into a spiral of cash flow problems even in a business where the underlying trade is profitable. Once in, it is difficult to break free from the spiral.

Cash flow issues become all consuming, meaning that management time is taken from carrying out other crucial tasks. A fire fighting mentality creeps in, errors increase, customers lose confidence and staff morale falls. Business books call this overtrading and describe situations when a profitable business has failed. In reality though, most businesses start to fail either because they are not profitable in the first place or because cash-flow problems stop management focussing on profitability. Company restructure can be the only solution.

Good advice should help prevent this doomsday scenario. It is crucial that management are given the information that they need, not bland accounting information designed for the 'average' company which of course doesn't exist.

Cash-flow forecasts and advice on methods of financing expansion are also critical.