Monday, April 6, 2009

Part 1 - Can a profitable company go out of business?

This was the very first question my instructor asked at the beginning of my first Finance class in my graduate program. He gave us a minute to think about it. The first answer that popped in my head is NO, a profitable company cannot go out of business.

Well, I was wrong!

The answer is YES, a profitable company CAN go out of business. It is simple business economics, but I guess the nerves had clouded my brain. If you don’t have any cash, but you are profitable on the books, then yes you can go out of business very quickly.

Many businesses are unfortunately finding this out in real time with our economy is the way it is. In a way, I think this correction is good. We have taken for granted the good times that many of us have experienced over the past 30 years and the majority of business owners have failed to understand the basics of Finance. Many feel it is too hard. I sure thought that too. What turned out to be the most difficult subject of my graduate program, also turned out to be one of my specialties 4 years later. I love Finance. I really do. Some of you may think I am crazy, but that is okay, I have been accused of worse.

Many of you may say, “But my Accountant told me this and I am okay”. Over 60% of business owners rely on their Accountants for Financial advice. But what are the Accountants using for their data when you get the financial advice?

The information YOU GAVE THEM! The information is typically what you have already done. Accounting is really a historical representation of the status of your business in a space of time.

So you fed your Accountant the information from the past month, they get back to you with a set of Financials and then you discuss how you are doing. This is the traditional approach to business. The major problem here is that by the time you get this information, your business has conducted another 60 days of business.

What if a problem popped up along the way? How do you correct when it is something you did 60 days ago? You can’t. If it is a recurring problem, you likely just did it for another 60 days and the hole could be much deeper than it was. So if your books show that you were profitable, but didn’t collect the cash that you had assumed you had, you could be in trouble with no where to go. So how do you fix something like that?

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