How profits can be misleading

A few months ago I worked with a business that was profitable on paper but nearly ran out of cash. The profit and loss account looked great, the order book was full, but the bank account was almost empty.

The business had a model that was a double-edged sword – it could invoice for works and services in advance, which sounds great, but the cash from clients didn’t come in advance. And they negotiated payment plans with most of their clients, who were in an industry that is notorious for slow paying.

The profit and loss account wasn’t right – the value of the sales invoices was recorded as revenue as soon as the invoices were raised, rather than over the term of the contracts. The business was making a loss, not the profit that they thought.

So the pipeline looked great and lots of invoices were going out, but as soon as contracts went live the costs to service them escalated before the sales invoices were paid. The sales team hit their targets, but the business was bleeding cash.

The business had no visibility over the future cashflows. The directors were making decisions based on flawed financial information and without understanding the cash impact of decisions.

Once I started giving them cashflow projections they could see what was happening and changed strategy quickly. They stopped selling, we chased client payments and scaled the business back in time to save it, with a little help from the bank.