Why Are Small Businesses with Growth Consuming Cash?
It’s a common problem for small business owners: your company is growing, and you’re sure it should be profitable, but The Business Cannot Generate Free Cash Flow.
What’s happening? This can be a difficult problem to diagnose because it requires understanding the differences between profitability and cash flow. In this blog post, we’ll explain what’s going on when fast-growing businesses experience cash flow problems and how they can solve them.
Profits VS. Cash Flow: The Problem Explained
The first step to understanding why you may be losing money even though your business is showing signs of growth is to understand the difference between profits and cash flow. Profitability refers to the amount of money that your business has earned after all expenses have been subtracted from total revenue. On the other hand, cash flow measures the amount of available funds that are moving through your business at any given time—that is, funds that are both coming in and out of your business over a certain period of time. Businesses can better understand if they have a profitability or a cash flow issue if they report their financials using accrual accounting methods.
What Is Accrual Accounting And How Do I Produce Accrual Financial Statements?
Accrual accounting is a method of tracking income and expenses based on when they are earned or incurred, rather than when cash is actually received or paid. This allows businesses to more accurately report their financials over time because it ensures that all revenue and expenses are included in the right period. Accrual-based financial statements provide a clearer picture of the overall health of your business and can also help you identify potential cash flow problems before they become an issue. Often fast growing businesses are generating profits, but are losing cash because of ‘Net Working Capital’.
Why Fast Growing Businesses Lose Cash Because of Net Working Capital
Net working capital (NWC) is defined as “the difference between a company’s current assets (such as raw materials, inventory, accounts receivable) and its current liabilities (such as debt, accounts payable).” For fast-growing businesses with increasing sales, NWC often increases because inventory and accounts receivable take longer to convert into cash than do accounts payable. This means that while profits show an increase due to rising sales, cash flow decreases due to the influx of NWC needed to fund operations.
How You Can Solve Your Cash Flow Problems If Your Cash Is Consumed by NWC
If you find your business in this situation, there are several strategies you can employ to help alleviate some of the strain on your cash flow: renegotiate payment terms with suppliers; reduce cost by decreasing overhead costs or streamlining production processes; get creative with financing options such as lines of credit or investor funding; or look into factoring invoice payments so that you can access payment more quickly rather than waiting for customers to pay their invoices according to their payment terms. All these options can help bridge the gap between profits and cash flow for small businesses experiencing rapid growth.
Understanding why small businesses with growth lose cash due to net working capital is key if you want to reverse this trend in your own company.
By recognizing the differences between profits and cash flow and taking proactive steps such as renegotiating payment terms with suppliers or seeking out financing options such as lines of credit or investor funding, small businesses can ensure they maintain positive cash flows even during periods of high growth—allowing them to capitalize on new opportunities without sacrificing stability in their finances.
If this is a problem that you are facing, Ballast is here to help. Our team of experienced professionals can help you by improving your financial reporting visibility to distinguish between profitability and cash flow by reporting on an accrual basis, and guide you through the various options to solve your cash flow needs.
Contact us today if you'd like to learn more!
