Oregon Small Business Development Center Network

My income statement says my business is profitable but my accountant says my business is failing!

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A look at small business questions from the Southwestern Oregon Community College Small Business Development Center (SBDC).
By Arlene M. Soto CMA, CGBP, Southwestern SBDC Director

My income statement says my business is profitable but my accountant says my business is failing. How is that possible?

Profits are different than cash flow. Profits represent revenue minus expenses. Most small businesses have uses of cash that are not expenses so not reflected on the income statement. Your accountant can provide insights into where cash is being used and how to keep the business from failing.

Accounts receivable could be part of the problem. Under the accrual method of accounting, revenue is recognized when an invoice is sent. Those sales will increase the net income on the profit and loss statement (also referred to as the income statement) but not be converted to cash until the invoice is paid sometime in the future. Cash flow could be a problem if accounts receivable are not being collected within a reasonable time. Look at the accounts receivable aging summary. To correct this problem, review credit terms being given to customers. Are they reasonable for the industry? Are customers paying according to the terms given or are they paying late? Put policies in place to collect as quickly as possible.

Inventory is another asset that uses cash until it is sold. Stock for sale may be sitting on the shelf longer than necessary. Some inventory may have been around so long it is obsolete. To determine if inventory is a problem, take a physical count. Review the dates inventory was purchased and the usefulness of the unsold items that have been on the shelf longer than normal. Reduce the price on those items that need to be moved. Discard or donate obsolete inventory to clear the shelves. Check to see if suppliers will accept returns or exchanges. Organize retail shelves to look full with fewer items. Review purchasing policies to make sure they meet customer demands, carry only the quantities that will be sold quickly.

The purchase of equipment or other fixed assets also uses cash that is not reported on the income statement. Another use of cash not reported as an expense is the repayment of principle on loans. Owner’s draws may be too high for the cash flow in the business and are also not reported as an expense. Verify there are no opportunities for employees to embezzle cash from the business. Implement theft deterrent policies, insurance companies often provide services to help.

Cash flow is more important to business success than profits. Many businesses fail because of poor cash management policies. Need more help? Contact your accountant or Small Business Development Center advisor to get an in depth analysis of where cash can be better managed.

The SBDC is a partnership of the U.S. Small Business Administration, the Oregon Small Business Development Center Network, the Oregon Business Development Department and Southwestern Oregon Community College. Arlene M. Soto has been the Director of the Southwestern Small Business Development Center since July 2007. To ask a question call 541-756-6445, e-mail, or write 2455 Maple Leaf, North Bend, OR 97459. Additional help is available at the OSBDCN Web page