Module 1: Cash Flow Foundations

Why Profitable Businesses Run Out of Cash

Many business owners believe that if they are making a profit, they are safe. In practice, a business can show a healthy profit on paper and still fail to pay rent, salaries or suppliers on time. Profit is a measure of performance over a period. Cash is what actually pays the bills today. When the two drift apart and nobody is watching, a growing, profitable business can find itself unable to meet its obligations. This lesson explains why that happens so you can spot the warning signs early in your own business.

Profit is recorded when you earn it, cash arrives when you are paid

Most businesses that keep proper accounts record a sale when the goods are delivered or the service is performed, not when the customer pays. This is called accrual accounting. If you deliver KES 500,000 of goods to a supermarket in March on 60-day terms, your March profit and loss statement shows the sale, but the money may only arrive in May. Meanwhile, you paid your supplier, your staff and your transport costs in March. Your profit says you did well. Your bank account says you are short.

The same gap appears with costs. You may buy a delivery van for cash, but your accounts spread its cost over several years as depreciation. The profit and loss statement shows a small monthly charge; the bank account shows one large payment that has already left.

The four common causes of a cash shortfall

1. Slow-paying customers. Sales on credit tie up cash in receivables. The longer customers take to pay, the more cash you need to keep operating.
2. Too much stock. Every item sitting on a shelf is cash that has been spent and not yet recovered. Buying in bulk to get a discount can make sense, but only if you can afford to wait for the stock to sell.
3. Growth. This surprises people most. When sales grow quickly, you buy more stock, hire more staff and extend more credit before the extra customer payments come in. Fast growth often consumes cash faster than slow growth.
4. Large one-off payments. Equipment purchases, loan repayments, tax payments and annual licence fees do not appear in profit in the same way, or at the same time, as they leave the bank.

Worked example: a growing distributor

Wanjiru runs a small distribution business in Nairobi supplying cooking oil to retail shops. All figures are hypothetical. She buys from a manufacturer on cash terms and sells to shops on 30-day credit with a 20% gross margin.

Each month is profitable: in March she earns a gross profit of KES 180,000. But in March she paid out KES 720,000 for stock and collected only KES 600,000, before paying rent, wages or fuel. Her bank balance falls by at least KES 120,000 in a month where the business looks better than ever. If March sales double again in April, the gap widens. Without a cash plan, Wanjiru could be forced to turn away orders or borrow at short notice on poor terms.

How to protect yourself

The answer is not to stop growing or stop giving credit. It is to know in advance how much cash each decision will need and when. In this course you will learn to separate profit from cash, map every inflow and outflow, measure how long your cash is tied up, build budgets and forecast your cash week by week. With those tools, a shortfall becomes something you see weeks ahead and plan for, rather than a crisis you discover when a payment bounces.

Common mistakes to avoid

• Judging the health of the business only by the profit figure or by whether sales are rising.
• Looking at the bank balance today without asking what payments are due next week.
• Treating money that customers owe you as if it were already in the bank.
• Paying for large equipment from operating cash without checking the effect on the next few months.
• Mixing personal and business money, which makes it impossible to see the true cash position of the business.

Keep these causes in mind as you work through the rest of the course. Almost every tool you will learn is designed to deal with one or more of them.