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A small business can show a profit on paper and still not have enough cash to pay its bills this week. The usual cause is timing: money goes out before customers’ money comes in.
This affects shop owners, their employees and the suppliers who wait to be paid. It also affects anyone thinking about starting a business.
A fictional example
This example is made up, and the math is ours. A small bakery sells $10,000 of catering orders in March. It pays $6,000 in March for ingredients and wages. On paper, the bakery made a $4,000 profit.
But the customers pay by invoice, and the money arrives in April. If the bakery began March with $3,000 in the bank, it needs $6,000 to cover its March costs and has no new cash coming in. It is $3,000 short, even though the sales are real and the profit is real.
Why the books and the bank can disagree
The Small Business Administration explains that businesses record sales in one of two ways. The accrual method counts a sale on the books as soon as the sale is done. The cash method counts it only when the payment arrives. In its example, a sale made in January with a $200 payment received in February shows up in January under accrual and in February under the cash method.
Under the accrual method, then, a business can look profitable in a month when it has not yet been paid.
Where else the cash goes
The SBA also notes that buying equipment with cash means less cash is left to cover operating expenses. Taking a loan spreads the cost over time, but the business pays more in fees and interest than buying outright with cash.
What owners can check
The SBA says a balance sheet is a snapshot of the business and helps owners keep a cash flow projection. Two items on it are worth a regular look: accounts receivable, which is money customers owe the business, and available cash. If receivables are growing while available cash is shrinking, bills may come due before customers pay.
JBizNews Desk | New York
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