False Profits

I thought all profits were real.  How can there be false profits?  Small business owners often focus too heavily on bottom line profits and miss out on the implications of their business decisions.  Here are five ways that business profits can turn into false profits and hurt more than they help.

1. False profits from sales.  It’s tempting to book sales as soon as possible because they can really help bottom line profits.  If the sales income, however, are going to come over time, a period of months or even years, resist the temptation to book the sale all at once and instead book them when the cash flows into your business.  That way you’ll have the cash to pay the taxes on that income.  Booking sales too early can result in false profits.
2. False profits from inventory.  This problem is especially prevalent in manufacturing companies where products are put into inventory at a standard cost.  A business can build bottom line profits, on the books anyway, by building inventory.  The increased asset value and absorption of costs leads to an increased book profit.  The real problem is that this strategy ties up cash and can lead to problems down the road.  Reduced cash balances can cripple a business and force owners and managers to make trade-offs that they might not otherwise make.  Be very careful with your inventory and always tie it to cash flow.  Oh, at some point you’ll have to stop or slow down production and reduce that inventory – you’ll pay the piper then.
3. False profits from transactions.  It may be tempting to do fancy off-the-books deals like Enron and others did to create profits out of paper transactions but don’t do it.  Many of these false profit transactions are illegal and most are not good business to say the least.
4. False profits from sweetheart deals.  Chainsaw Al Dunlop and his team increased the book profits for Sunbeam by offering special deals to customers.  They took on huge inventories and Al booked the transactions as sales to create large false profits.  This method is often illegal and will unravel over time when inventories and sales have to be balanced.
5. False profits through fraud.  Let’s face it; there are too many people out there who want to take your money without any regard for law and ethics.  For example dozens of multi level marketing schemes pop up and disappear a short time later.  The founders and the first few people into the scheme may make money but the profits promised to the followers soon turn out to be false profits.  When someone says that all you need to do to succeed is to get in on the ground floor, that’s a good time to look for the door.  Real profits are built over significant time; false profits are promised overnight.

Good business generally requires hard work over time.  Shortcuts can lead to false profits.  Also remember that positive cash flow is often more important than profits.  Keep a positive cash flow and then work on your real profits.