For example, it's possible for a company to be both profitable and have a negative cash flow hindering its ability to pay its expenses, expand, and grow.
Yes, even a profitable business can have cash flow problems. If your sales are strong, but you're not being paid, or you're spending too much, you might not have the cash flow to keep operating efficiently.
Simultaneous: It's possible for a business to be profitable and have a negative cash flow at the same time. It's also possible for a business to have positive cash flow and no profits.
A business could make net profit while having negative cash flow. Earning revenue does not necessarily mean that the company has received cash immediately. The actual movement of cash may happen later. For instance, a company sold goods and accrued profit on the income statement but did not receive the money yet.
According to a study, 82% of small businesses fail because of cash flow problems. This means that even if a business is profitable on paper, it can still go under if it doesn't have enough cash on hand to pay its bills and expenses.
While profit is the goal – and an indicator of financial health – cash flow is the lifeblood of an organisation, keeping operations ticking over on a day-to-day basis. For a growing business, both cash flow and net profit are important, but in the short-term, cash flow is probably the number one concern.
A business can show an accounting profit and an economic loss because of the existence of implicit costs. To have an accounting profit, a firm must earn enough revenue to cover its explicit costs. To earn an economic profit, a firm must earn enough revenue to cover its implicit and explicit costs.
Profit & Loss Statement
A negative revenue figure may mean that you had to credit a customer or customers for more than you sold in a given period.
However, over a certain period of time, a company may be profitable but still have cash flow difficulties. This is mainly due to the accrual basis of accounting, where revenues and expenses are recorded as they are incurred, not received.
Negative cash flow is when your business spends more than what it receives, but this need not always indicate a loss. For example, your payments may be due before you receive your income and you may spend more than what you have at that time, leading to a cash flow problem.
Everyone knows that starting a business requires cash, and growing a business requires even more—for working capital, facilities and equipment, and operating expenses. But few people understand that a profitable company that tries to grow too fast can run out of cash—even if its products are great successes.
Cash Flow Issues and Business Failure
Many small businesses fail because of cash flow problems. Poor cash flow management skills and a poor understanding of cash flow rank ahead of other common cash-related reasons for business failure, including too little start-up money and running out of cash.
The cash conversion cycle, or CCC, measures the time in days from initial investment to receipt of payment. Normally, this metric is positive because a business purchases inventory before selling it and receiving payment for the item. Yet it's also possible for the cash conversion to be negative.
You can still use the DCF model to value a company with negative cash flows as long as those cash flows are estimated to become positive at some point in the future. Simply treat all cash flows the same, whether they're negative or positive, by discounting them to the present.
Lastly, it is not possible to have accounting losses but economic profits because economic profits or losses are always less than the accounting profits or losses.
For example, imagine a company has $100,000 to invest. If it declines one opportunity for another, the potential income from the declined opportunity is factored into economic profit but not accounting profit.
Enlisting the services of a qualified CPA to prepare your P&L statements and/or to provide advice will save you time and money in the short and long-term.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization and is a metric used to evaluate a company's operating performance. It can be seen as a loose proxy for cash flow from the entire company's operations.
Depreciation and Amortization:
They reduce net income but do not affect the actual cash on hand. A company can have significant depreciation and amortization expenses that lower net income while still maintaining positive cash flow.
It's entirely possible to be in profit and run out of cash, or vice versa. A negative cash flow doesn't necessarily mean that you're making a loss, since cash flow only refers to liquid assets.
82% of small businesses fail due to cash flow problems.
Negative cash flow isn't necessarily a bad thing if you're following a plan. However, you want to avoid running out of cash entirely. To avoid this situation or simply to improve your business cash flow, you may want to consider exploring available business funding sources.