How profitable businesses fail – eComFuel

This is a post in our series on Financial Mastery for eCom Owners, specifically Commandment #2: Master Your Financial Statements.

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Your P&L could show record high profits. And you may be on the verge of bankruptcy.

It sounds impossible. But it’s more common than you think.

I’ve watched store owners celebrate their best year ever, then two months later they’re scrambling for paychecks.

The problem is not that they are not profitable. The problem is that they misunderstood what their financial statements were telling them.

Your business is an airplane

Here is the framework that finally made it click for me.

Think of your business as an airplane. You have three tools to monitor:

Income statement = your trajectory. It will tell you if you are heading towards a sustainable and healthy business. If you stay on this path, will you end up where you want to go?

Balance sheet = your structural integrity. It will tell you if your plane can handle turbulence. If you hit a storm or need to make a sharp turn, will the wings stay on?

Cash flow = your fuel. You can have the nicest Gulfstream 7 on the planet. Perfect trajectory. Beautiful structural integrity. You run out of fuel and you go down. Hard.

Most business owners are obsessed with the bottom line – their trajectory. Sometimes they look at the balance sheet. They ignore cash flow until it’s an emergency.

It’s like staring at a compass while the fuel gauge drops to empty.

Why profitable businesses fail

Here is the scenario that keeps playing out.

You have a great year. Your P&L says a profit of $250,000. You feel good.

But that cash isn’t sitting in your bank account.

$150,000 went back into stock for next year’s growth. Another $100,000 went to cash outflows that never hit your P&L—deposits for purchase orders, debt payments, owner distributions.

Bank account: empty.

Profit is an opinion. Cash is a fact.

Then the IRS calls. They want taxes on your $250,000 paper profit. That’s $75,000.

You owe $75,000 with nothing in the bank.

You are underwater in your best year. Because profit is an opinion. Cash is a fact.

Balance will tell you if you survive

Let me choose between two businesses.

Business A:

• Revenue increased by 50%
• Contribution margin: 30%

Company B:

• Revenue increased by 20%
• Contribution margin: 25%

You want Business A, right? Grow faster with better margins.

Bad choice.

Company A turns over inventory once a year. All that cash is trapped in slow-moving stocks. They have two weeks of operating expenses in the bank.

Company B turns over inventory four times a year. They have cash reserves for 4 months.

Business A looks great on the income statement. But the balance sheet reveals the truth: one surprise expense and you’re done.

Business B survives.

Inventory turnover and cash reserves

Two important metrics to watch:

Inventory rotation:

• 30-45 days: Elite management
• 2 months (6x/year): Pretty great
• 2-3 months: Average to good
• 4-6 months: Longer than ideal
• 6+ months: Below average, something is wrong

Cash reserves:

• The goal is 2-6 months of operating costs
• More difficult for fast-growing businesses, but still critical
• Cash gives you options when things go wrong

Balance sheet hygiene

Your balance sheet only helps if it is set up correctly.

Make sure you have sub-accounts for:

• Inventory on the way
• Prepaid expenses
• Liabilities (especially pre-order money)

Pre-order money deserves special attention. If customers pay you before delivery, that’s a liability – not your cash. I have the money from the pre-order in a completely separate account. It looks like my money. it isn’t. It’s a huge commitment until delivery.

Without proper organization, you will look at your bank balance and think you have more than you do.

Cash Flow Forecasting: Stop Looking Back. Start looking forward.

The statement of cash flows is one of the three official financial statements. It’s also the least useful for actually running your business.

Why? It’s a look into the past. It explains why you ran out of money – eventually.

You need a 13-week cash flow forecast.

This is a forward-looking projection of your cash position. You estimate:

• Sales per week
• Known expenses
• Upcoming purchase orders
• Tax payments
• Any big money events

Then see where you will be in 4, 8, 12 weeks.

You will be wrong. That’s okay. It’s not about accuracy, it’s about visibility. You want to see the financial crisis coming while you still have time to react.

Your accounting software won’t do it for you. QuickBooks and Xero track history; they do not predict the future. Most operators do this in a table.

Not sure how to do a cash flow forecast? I got you covered. Join the ECF newsletter and I’ll send you a variety of financial resources and tools, including a customizable cash flow model I created, along with instructions on how to use it.

Your task

Answer these three questions:

1. How many months of operating expenses do I currently have in the bank?
2. How many times per year does my inventory turn over?
3. Do I know what my cash position will look like in 8 weeks?

If you can’t answer all three with confidence—or you’re worried about the answer—you’ve found your priority.

Your P&L tells you where you are headed. Your balance will tell you if you will survive the trip. Your cash flow will tell you if you have enough fuel to get there.

Track all three tools. Not just the one who feels good.

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