Keeping your business cash liquid – the difference between cash flow and profit

Cash is King – Businesses Can Have a Profit, Without Generating Cash

The foundational goal of any business is to make a profit. As a business owner, that’s one of your key financial aims – to make enough sales, at a big enough margin, to generate profit from your enterprise. But how does profit differ from cash flow? And why is cash king?

How do profit and cash flow differ?

To really understand the difference between generating profit and managing cash flow, we need to look at what both these terms mean. You might think that delving into the accounts is a job for your adviser, but being in control of your profit and cash flow is an invaluable business skill.

Let’s take a look at the differences:

  • What is profit? – Profit is the surplus that’s left from your income once you’ve paid your expenses, supplier bills and tax etc. It’s driven by creating a profit margin and generating value from your products and/or services.
  • What is cashflow? – Cashflow is the ongoing process of ensuring that the business has the available cash (or ‘liquid’ cash) needed to operate. This provides the money needed to trade, to pay suppliers, to cover wages or to buy raw materials etc.  Money in versus money out.

Why is positive cash flow so important?

‘Cash is king!’ may be a cliche these days, but it’s a maxim which underpins any successful business model. Yes, it’s great to make a profit at year-end, but if you don’t look after your cashflow then the business may not survive as long as the end of the year.

What’s needed is good cashflow management to enhance your financial health. And without a careful eye on your cash numbers, things can quickly go awry.   Checking there is money in the bank account is not enough – keeping an eye on upcoming expenses helps avoid the bumps in the road.

A business can generate high revenues and big profits, but still be cashflow poor. In other words, it can have profits at the end of the period, but have very little liquid cash to fund it’s day-to-day operations over the course of the period.

Where does it go?

Money in to your business comes from sales, loans advances to the business, selling assets and funds invested by shareholders. Money out of your business pays for stock, consumables, operating expenses and wages.  Other outgoings include taxes, loan repayments, purchasing assets.   As a business grows it needs more money coming in to cover the costs of extra stock, plant and overheads.

A prime example is when you customers are paying you on the 20th of the monthly following invoice and you are paying for stock on a 7 day invoice.  You could have paid for the stock weeks before you get paid by your customer.

In a growing business timing increases outgoings against increasing sales is often complicated and a recipe for disaster.  But many things can help, tightening credit terms for customers, purchasing new assets financed from a loan rather than from reserves.

Well run businesses always have cash reserves, and if 2020 and 2021 have taught us anything it is the need for businesses to hold cash reserves.

Talk to us about improving your cash flow management

Good cashflow management is all about being in control of your cash inflows (income you’re generating) and your cash outflows (what you’re spending). To achieve ‘positive cashflow’ you need to proactively work to keep your inflows higher than your outflows.

As your adviser, we’ll help you set up detailed cashflow reporting and forecasting, so you can keep the business in that ideal positive cashflow position. And we’ll also look at key steps for keeping your revenues high, margins profitable and meeting your financial targets.

Get in touch to talk through your cashflow management.

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