Business Can Be Profitable but Short of Cash

Question: Our business is profitable, but we’re always short on cash. If we have profit, why don’t we have cash?

Answer: As you’ve discovered, profit and cash are different, and both are needed for a company’s long-term health.

Karen Berman, co-author of “Financial Intelligence: A Manager’s Guide to Knowing What the Numbers Really Mean” and founder of the Business Literacy Institute near Los Angeles, laid out four essential reasons profit and cash are not the same thing, and they can be explained by looking at your company’s income statement.

Your income statement shows your sales, expenses and profit -- typically for a month or a year. The first thing to realize is that revenue shown on your income statement is not incoming cash but a promise from your customers to pay for your product or service. That revenue usually is not collected for 30 to 60 days or longer. So, although that sale is reflected in determining your profitability, it does not necessarily mean that the cash is coming into your account during that period.

Second, in order for your income statement to help you understand the profitability of your business, you must match your expenses to your sales. That is, you want to know what expenses were incurred to make those sales. That means that the expenses shown on your income statement may not be what you bought that month, or even what you paid for that month.

Third, when you make a large purchase for business equipment, called a capital expenditure, you may pay for it with cash, but the entire cost of that equipment is not included in your income statement, and so it is not reflected in your profit number. Instead, the item is depreciated, so that a certain amount is included as an expense every month over the life of that equipment.

Fourth, you may have cash going out to pay off some debt, but the payment of loan principal also does not show up on your income statement. For all these reasons, it is not uncommon for entrepreneurs whose firms are profitable on paper to find themselves chronically short of cash.

You can get a sample cash flow calculator online at www.bplans.com. Another address you may find useful is www.investorwords.com; it has a financial glossary that gives quick definitions of business terms.

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Look to Clients to Create a Good Marketing Plan

Q: My firm has always generated business through meeting with people and word of mouth. How can I develop a formal marketing plan?

A: Informal networking and word of mouth can sustain new firms for a time. But as they grow, most businesses need a marketing plan to provide a blueprint for growth, says Barbara Lewis, principal of Centurion Consulting Group in Beverly Hills.

Lewis suggests that you develop a plan yourself or engage a consultant. The typical fee would probably be $5,000 to $20,000 and includes analyzing your client database and creating a plan to capitalize on the results of that analysis.

If you decide to do it yourself, start by “data mining” your client records for the last several years to identify crucial trends. A client database is key for your company’s future growth, so if you don’t have one, create one in Microsoft Excel or Access. Look at what industries your clients come from, how they were referred to you and what kind of revenue they generate. Many of my clients haven’t engaged in this kind of critical inspection, but once they do, they are shocked to discover how business has arrived at their doors.

One executive found that a speech she had given at a conference was an excellent source of clients, yet she had turned down follow-up speaking requests because she didn’t recognize their value. Another entrepreneur discovered that his business was increasingly coming from construction contractors. Once he knew this, he joined construction networking organizations, spoke at construction seminars, wrote for construction publications and e-mailed a newsletter to the companies in his construction database.

Once you grow beyond tracking how each customer is generated, you can use a sophisticated statistical technique called econometrics or market response modeling. This process helps uncover the effect of your marketing activities by comparing changes in what you’re spending on marketing with variations in your revenue, profit and market share over time. The results will guide you in allocating your marketing dollars for the greatest return.

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Got a question about running or starting a small enterprise? E-mail it to karen.e.klein@latimes.com or mail it to In Box, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012.