5 Ways a Profitable Company Still Goes Broke—and How to Prevent It

Profitability and cash flow—two terms often used interchangeably—could not be more different.

And yet, countless businesses that report strong profits find themselves scrambling to pay bills, meet payroll, or keep the lights on. How is this possible?

Let us unravel the mystery behind why profitable companies still go broke—and, more importantly, how you can avoid this financial trap.

The Profit vs. Cash Flow Dilemma

At its core, profitability is a measure of what is left over after all expenses are deducted from revenue. It looks great on paper, but it does not guarantee cash in the bank. Cash flow, on the other hand, is about liquidity—the money you have available to cover day-to-day operations.

Here’s how things can go sideways:

Timing Mismatches:

• • Imagine sending out a big invoice for a completed project, but your client takes 90 days to pay. Meanwhile, your suppliers want their money yesterday. Profitable? Yes. Broke? Also, yes.

Overexpansion:

• • Growth is exciting, but rapid expansion can drain cash reserves. Those new hires, bigger office spaces, and fancy equipment do not pay for themselves overnight.
  • These are all Fixed Costs that you must have the Gross Profit to cover.
  • For every new Fixed Cost planned take the monthly amount and divide it by your Gross Profit Margin.
  • Let us say you want to hire a new operations manager; The cost is $7,500 per month. Your Gross Profit Margin is 30% (the amount left over after direct Cost of Goods Sold are deducted from your sales, expressed as a percentage).
  • $7,500 divided by 30% equals $25,000. You need at least $25,000 in new sales to cover that new operations manager.
  • Do this with every new Fixed Cost to become aware of how much you need to cover this extra cost in your business.

Poor Inventory Management:

• • For businesses dealing with physical goods, tying up cash in slow-moving inventory is a surefire way to squeeze liquidity.
  • I once coached a business (not a client; I did it as a favour) that was profitable for 35 years. They could not figure out why they showed great Net Profit and yet were struggling to pay their bills.
  • On examining their Balance Sheet I quickly discovered that the bookkeeper had been recording some of the Cost of Goods Sold as inventory purchases. Thus, their expenses were understated and Net Profit overstated.
  • The inventory on the Balance Sheet was not real inventory that could be sold.
  • The owners were not amateurs; they were just overfocused on the Income Statement and ignoring their Balance Sheet.

Debt Overload:

• • Interest payments on loans or lines of credit can quickly eat into cash, especially if revenue is not rolling in as planned.
  • Especially, also when interest rates go up exponentially when debt is up for renewal.

Ignoring Hidden Costs:

• • Costs like taxes, employee benefits, or unexpected repairs often catch businesses off guard, draining available cash.

How to Prevent the Cash Flow Crunch

Now that we have pinpointed the culprits, here are practical steps to prevent your business from becoming cash-strapped:

Forecast Your Cash Flow:

• • Regularly track and predict your cash inflows and outflows. Tools like Xero, ApprovalMax and Fathom can help you stay ahead of surprises.

Tighten Payment Terms:

• • Do not let clients dictate payment terms. Consider incentives for early payment or use tools like Plooto to automate and streamline collections.

Build a Cash Reserve:

• • Aim to keep at least 3-6 months of operating expenses in a savings account. This buffer can shield you from unexpected shortfalls.
  • Most personal financial planners recommend this, yet too few businesses follow this same advice.

Control Growth Pacing:

• • Grow strategically. Before making big moves, assess how they will impact your cash flow over the next 12-24 months.

Review Debt Regularly:

• • Consolidate or refinance high-interest debt to lower your monthly obligations. Be mindful of the balance between leverage and liquidity.

Monitor Metrics That Matter:

• • Keep an eye on key metrics like Days Sales Outstanding (DSO), inventory turnover, and operating cash flow. These will give you an early warning of potential problems.

Stay Cash Flow Confident

Remember this – a profitable business is different from a healthy one. By focusing on cash flow, you will ensure your company not only survives but thrives.

Want to dig deeper into your financial metrics or get a handle on cash flow management? Let us talk. We specialize in helping businesses like yours bridge the gap between profitability and liquidity—so you never have to worry about going broke while turning a profit.

Thanks for reading…