I’m Making Money, So Why Don’t I Have Any?

Cash and having enough to meet the needs of a small business can become an overwhelming concern for the business owner. This can be particularly trying when the profit and loss statement indicate that the company is doing well. Small organizations may not have the internal expertise or relationship with external professionals to understand how cash can be tied up in assets or liabilities and that leads to the obvious statement, “I’m making money, so why can’t I tell it? We never seem to have enough cash to pay our bills!”

For most businesses, finding these answers can be very quick. Let’s assume the following facts: The Company has recognized profit year to date but the Line of Credit is almost fully utilized with a maximum borrowing cap of $500,000 and knowing the Company has little availability on the line is weighing on management.

Sales are up over 30% or almost $184,000 more per month and that is driving receivables and inventory higher. Ownership wants to know when the improved profitability will start to really feel like an improvement.
The answer can be found by comparing the numbers on the balance sheet. Any asset, that isn’t cash that increases in value “uses” cash or if those assets decrease, cash is generated. Liabilities work exactly contrary to those rules. A liability that increases generates cash, because you haven’t yet written a check that would reduce your cash balance. When liabilities decrease, like bank loans, cash increases. In the example above, cash remains the same so cash there should be an equal amount of cash generated and used. The uses of cash are accounts receivable and inventory and payments against bank loans. Cash is generated by borrowing against the line of credit and from profits which are recognized by the change in equity.

In this example, Accounts Receivable is up 42% but the increase in sales is only 30%. This means that over Accounts Receivable is over $90,000 higher than might be expected. Management should look to insure that receivables are not aging. Often

Multi-Year Balance Sheet

when sales increase, there is a corresponding “softening” of credit terms. This can lead to higher uncollectable balances and bad debt expense and slower payments from customers.

On the other hand, even though Inventory is also 18% higher, this is actually less than could be expected for the sales increase but it is another use of cash. The reduction in bank loans is a further reasonable outflow of cash and has been anticipated by management.

The real challenge, however, is accounts payable. With higher sales and more inventory goods it would be reasonable for accounts payable to increase. But the balance has remained the same. Often, especially for firms that have struggled with profitability, aging of payables becomes an issue. That is the case with the firm in this example. At the start of the year, payables were almost as high as receivables, almost always a sign of tight cash.

Quite reasonably, the company wants and needs to meet the financial requirements of suppliers and begins reducing payables when profitability starts. This doesn’t mean that all pressure ends though and the result is that the organization feels like there is no relief against this stress. Fortunately, profits and payments against these balances eventually do add up and the company is able to get back to “normal” terms with the supplier and then, provided that management properly controls inventory and accounts receivable, profits will begin to “felt” by the organization.

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