Profitability Principal 3 - Profits and Cash Flow are usually not the same thing.

Cash either leads or lags profits. An increase in your accounts receivable balance means that while sales may be up, the cash has yet to come in. Conversely, you could be loosing money and not realize it due to strong cash flow produced by lowering accounts receivable and inventory balances.

It’s not all that hard to temporarily produce positive cash flow while suffering a loss of profits. A new loan will do it. However, the only way to produce long-term positive cash flow is to produce profits. You can’t borrow your way to prosperity so concentrate your management time on producing profits rather than cash.

There are two big factors that produce a difference between cash flow and profits. Accounts receivable and more importantly inventory levels. Failure to keep your A/R current and your inventory levels low will begin sucking up cash faster than your profits can generate them. Additionally, high inventory and receivables inevitably results in eventual losses due to write-offs. Many times these losses are not discovered until year-end when it is too late to do anything about it.

If a business that is in danger of collapsing then the only thing that counts is cash flow, not profits. This strategy only buys time for a new plan to work. With a new plan, maybe you can save it. Without a new plan there is no chance for success. In my experience, you are better off minimizing the loss to the owner by giving it up and moving on with your life.