How Profitable Businesses go Broke
Friday, October 29th, 2010
Two terms that people treat as synonyms in small business are profit and cash. Let me tell you this before your bum winds up at the bus station because your partner left you with the children – profitable businesses go broke all the time.
The Difference between Profit & Cash
A profitable business is one that is economically moving ahead. The simple example would be that the money being earned by the business is greater than the costs associated with running the business. That’s simple.
However, the life blood of any business isn’t profit. In the real world profitable businesses go broke all the time. You can be the best at what you do, you can be working 16 hour days for profitable labour… you can have 20 premium clients knocking on your agency’s doors to the point you’re pushing them away with a broom.
Businesses run on cold hard cash.
The wheels of business, although it’s far from the romantic vision, are the dollars greasing one’s palm to pay short term debts as they fall due. If those debts fail to be paid on time then you’re probably done. Finished. The receivers get called in to sell off any assets to pay those debts.
Stating the Obvious… Money in the Hand
The most important responsibility on your business plate is to ensure that cash keeps flowing through your accounts. This sometimes means saying no to ‘profitable projects’ that can’t provide short-term cash security.
The importance of understanding this simple piece of business logic is fundamental to every freelancer, small business and corporation. What happened at Enron? It was definately profitable on their ‘managerial accounting’ books using obscure investments in derivatives. Argue with that statement as you want but businesses keep two sets of books. Regardless, four out of Enron’s last five years turned over zero cash and paid zero tax… the tax department don’t particularly care about pie-in-the-sky ‘managerial accounting’ profits or methods of amortisation and depreciation or even goodwill… they look at the ‘financial accounting’ books – cash flows in and out.
