Some entrepreneurs believe that as long as the cash register is full and money flows into the account regularly, the business is thriving.
However, this is the most deceptive financial trap of all. High turnover does not automatically mean your company is making a profit. Many businesses go bankrupt at this exact juncture—simply because they mistake net profit for cash flow.
To understand the difference, let’s look at a simple scenario: Your company has signed a lucrative contract and shows a 50,000 AZN profit on paper (this is your P&L, or Profit and Loss statement). However, if the client is not going to pay this amount for another 90 days, you currently have 0 AZN in cash. Meanwhile, next week you have to pay employee salaries, office rent, and taxes. On paper, you are wealthy; in reality, you are on the brink of default. This is a classic Cash Flow problem.
The reverse can also happen: You might receive massive upfront advances from clients, leaving your cash register overflowing. However, that money represents unfulfilled obligations, and once all future expenses are deducted, it may turn out that the business is actually operating at a loss.
What should you do?
To avoid driving your business blindly, you must follow two golden rules:
- Measure your actual profitability using P&L statements.
- Forecast cash movements in advance using Cash Flow statements (and maintain a payment calendar).
If you cannot read the numbers correctly, scaling your company is impossible. Do not put your business at risk.
FGAC Recommendation: To establish professional management accounting and automate financial reporting in your company, contact the team at Finance Group Accounting and Consulting. We make the numbers speak your language.
