Cash Flow Basics: Why Profitable Businesses Fail
Here's a brutal truth: 82% of small businesses that fail do so because of cash flow problems. Not because they weren't profitable on paper—but because they ran out of actual money to pay bills. This guide explains why that happens and how to prevent it.
Profit vs. Cash Flow: Not the Same Thing
Profit is an accounting concept. Cash flow is reality. You can be profitable and still go bankrupt if you don't have cash when bills are due.
Profit
- Revenue minus expenses
- Recorded when earned (not when paid)
- Includes non-cash items (depreciation)
- Can exist on paper without cash
Cash Flow
- Money in minus money out
- Recorded when cash moves
- Only counts actual cash
- What you need to pay bills
The Classic Trap
You invoice a client $10,000 in January. Accounting says you have $10,000 revenue. But the client pays net-60. You won't see cash until March. Meanwhile, rent is due February 1st.
Reading a Cash Flow Statement
A cash flow statement shows where money came from and where it went. It has three sections:
1. Operating Activities
Cash from your core business: customer payments, supplier payments, payroll, rent. This should be positive for a healthy business. It's the most important section.
2. Investing Activities
Cash spent on long-term assets: equipment, property, vehicles. Usually negative (you're spending). A growing business invests; a dying one doesn't.
3. Financing Activities
Cash from loans, investors, or owner contributions. Also loan repayments and dividends. Positive when raising money, negative when paying it back.
Simple Cash Flow Example
The Timing Problem
The #1 cash flow killer is timing mismatch: you pay for things before customers pay you. Here's how it plays out:
A Profitable Business Running Out of Cash
January: You land a $50,000 contract. Exciting!
February: You buy $20,000 in materials and hire contractors for $15,000. Cash out: $35,000.
March: Project delivered. Invoice sent with net-30 terms.
April: Rent ($5,000) and payroll ($10,000) are due. Still waiting on payment.
April 15: You're $15,000 short on cash. The client finally pays April 30.
Profit on paper: $15,000. Cash in bank when bills are due: negative.
Common Timing Traps
- Inventory: You buy inventory months before selling it
- Net terms: Customers pay in 30-60-90 days
- Seasonal business: Revenue spikes but costs are constant
- Growth: Scaling requires upfront investment before returns
- Project work: Expenses during project, payment after completion
Simple Cash Flow Forecasting
You don't need fancy software. A spreadsheet with 13 weeks (one quarter) of projections will catch most problems before they happen.
The 13-Week Cash Flow Forecast
- 1. Start with current cash balance. What's in the bank today?
- 2. List expected cash inflows by week. Be conservative. Only
count money you're confident will arrive. Include:
- Customer payments (based on actual invoices and their terms)
- Recurring revenue
- Any other expected deposits
- 3. List expected cash outflows by week. Be thorough. Include:
- Payroll (including taxes)
- Rent/lease payments
- Supplier payments
- Loan payments
- Insurance, subscriptions, utilities
- Estimated variable costs for new sales
- 4. Calculate weekly ending balance. Starting + Inflows - Outflows.
- 5. Flag any week where balance goes negative or near zero. That's your warning sign.
Pro Tip: The 80% Rule
Multiply expected inflows by 80%. Some payments will be late or not come at all. This builds in a safety margin. If your forecast still works at 80%, you're probably safe.
Improving Your Cash Flow
You have two levers: get money in faster, or slow money going out. Here are concrete tactics for both.
Speed Up Inflows
Invoice Immediately
Don't wait until month-end. Invoice the same day you deliver. Every day you delay is a day longer until payment.
Shorten Payment Terms
Net-30 is standard but not mandatory. Try net-15 or net-7 for smaller invoices. Offer 2% discount for payment within 10 days.
Require Deposits
For projects or custom work, get 25-50% upfront. This covers your initial costs and filters out non-serious clients.
Accept Multiple Payment Methods
Make it easy to pay you. Credit cards, ACH, even PayPal. Yes, there are fees, but getting paid faster is usually worth it.
Follow Up on Late Payments
Send reminders at day 25, day 30, and day 35. Call on day 45. Be polite but persistent. The squeaky wheel gets paid.
Slow Down Outflows
Negotiate Supplier Terms
Ask for net-30 or net-45 instead of paying upfront. Good suppliers want your repeat business and will often agree.
Time Your Payments Strategically
Pay on the due date, not before. If a bill is due the 15th, schedule payment for the 15th, not the 1st.
Reduce Inventory
Every dollar in inventory is a dollar not in your bank. Order more frequently in smaller quantities if possible.
Lease Instead of Buy
Equipment leases spread costs over time. Yes, you pay more total, but you preserve cash for operations.
Keep a Line of Credit
Get approved when you don't need it. A business line of credit is insurance against timing gaps. Only use it short-term.
Warning Signs of Cash Flow Problems
These symptoms mean you need to act fast:
Red Flags
- ● Delaying payroll — The clearest sign you're in trouble
- ● Paying bills late consistently — Not by choice, but necessity
- ● Using credit cards for operating expenses — Dangerous spiral
- ● Turning down sales — Because you can't fund the work
- ● AR aging increasing — Customers taking longer to pay
- ● Cash balance trending down — Less cash each month despite profits
Emergency Actions
If you're already in a cash crunch:
- 1. Call your biggest outstanding invoices. Ask for immediate payment or partial payment.
- 2. Talk to your landlord/biggest vendors. Negotiate payment plans before you miss payments.
- 3. Cut non-essential spending immediately. Subscriptions, travel, discretionary purchases.
- 4. Consider invoice factoring. Get 80-90% of invoice value now (expensive, but better than closing).
- 5. Owner injection. If you have personal savings, a short-term loan to the business may bridge the gap.
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