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The Effect of Operating Losses on Cash Flow

Posted on July 15th, 2017

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

A while back I read an article on managing cash flow in which the author made this statement: “While they might seem similar, profit and cash flow are two entirely different concepts, each with entirely different results. The concept of profit is somewhat broad and only looks at income and expenses over a certain period, say a fiscal quarter. Profit is a useful figure for calculating your taxes and reporting to the IRS.”

Well, while I understand the author’s overall point, the last sentence above is one of the most shortsighted comments I have ever heard. This article was obviously written by someone who specializes in tax preparation vs. corporate finance. As I have talked about in several articles, profit is not just a “number,” it’s a critical component of cash flow, and without it, the business will eventually die.

To illustrate, let’s refer again to my sample company from my last two articles on the topic of improving cash flow by improving receivable collections and slowing payments on accounts payable. This time, however, let’s assume the business experiences operating losses, say from the loss of a major customer. The below Profit & Loss, Cash Flow Statement, and Asset-Based Credit Facility – Borrowing Availability, reflect the dramatic impact that operating losses have on cash flow:

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Note the large “over-advance” on the line of credit. This reflects the funding requirement from external sources caused by the operating losses. The reality however, is that a bank isn’t going to knowingly fund these losses, as profit is (ultimately) what repays debt in the first place, so in lender terminology, there is no “source of repayment.”  Nor will most investors who are also looking to the company’s earnings for a return on their investment.

One other comment about the author’s statement I quoted above, profit on a cash-basis tax return is actually “cash flow.” Thus, a company with declining sales and receivables can (temporarily) show a “profit” on a tax return, when behind those numbers, the company is actually losing money and on its way out of business.


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