Benefits of a Positive Cash Flow
You’ve got a great product or service—and people are buying – so why is your business broke? No matter how profitable your business seems on paper, you’ll struggle every month if you don’t focus on and fully understand your cash flow.
Profit vs. Cash Flow: What’s the difference?
What is Profit?
At its most basic level, profitability is determined by taking the amount of money you have coming in and then subtracting your costs and expenses. You could sell a million dollars’ worth of product, but if it costs you 1.5 million to create, market, sell and ship those products, you’ll be losing money and make no profits, despite your impressive sales figures. You’ll also struggle if you make sales, but don’t get immediate payment; you’ll still have to pay vendors, taxes, production costs and more, even though the actual money has not arrived yet.
Profit is more of a concept – you can’t spend it until it actually arrives in your bank account (and all other expenses have been paid). While focusing on profit can let you know how well you are doing as part of a larger financial picture, it doesn’t relate how your business is performing on a day-to-day level of operations. It is possible to show a profit for the year – but have no money in the bank or to operate your business at all. Businesses that operate on a repeat sales or subscription model often show a profit early in the year, but struggle with cash flow; the sales “count”, but the money has not yet arrived or become available for use.
What is Cash Flow?
Your business cash flow is the amount of actual revenue that comes in – and goes out – in a stated period. To measure cash flow, you’ll look at your available cash at the beginning of a set period and compare it to the amount of cash at the end of the period.
Since cash flow measures actual revenues, it is easier to predict how much money you’ll have in a set period of time and to forecast how you’ll do the immediate future. Cash flow measures actual income, revenues that are in your hands and available for use in your business. Where profitability is somewhat subjective, cash flow uses real facts and figures and allows you to get a real time look at how your business is doing.
Why Cash Flow Matters more than Profit
Thanks to the accrual method of accounting, which considers the sales you’ve made but not been paid for, tracking profits can’t accurately predict how much money you’ll have in hand each month. Focusing on cash flow gives you real information that you can use to make decisions and predict what you need to do in the near future.
A few key benefits of focusing on creating a positive cash flow include:
- Lowered Stress Levels: If you struggle with wondering when you’ll be able to pay the bills and cover the expenses that keep your business running, then focusing on cash flow is a must. The electric company doesn’t care that you’ll eventually see a profit – they want to be paid every month (preferably on time). Knowing just how much money you have coming in to address even the mundane aspects of running your business can reduce your stress levels and prevent you from wondering “where” that money is going to come from. Knowing what to expect allows you to truly be proactive and plan things out in advance and alleviates the worry that comes from fearing the unknown.
- Advanced Notice of Shortfalls: If you are simply using profit to guide your budget, you could be in for some nasty surprises. Looking at your accrued sales can give you a false sense of security and allow you to be blindsided when you don’t have enough cash on hand to pay an obligation. Tracking cash flow won’t protect you from shortages, but it will give you more advance notice and time to come up with a plan.
- Leverage for Credit: Banks love to see a positive cash flow; you’ll be showing that you can not only turn a theoretical profit, but generate actual income. Having a positive cash flow makes it easier to borrow when you need to; subjective profit statements may not be enough.
Learning about the difference between profit and cash flow can save you a lot of headaches and help ensure that your business succeeds. The best way to determine how you are doing – and what you can expect based on your cash flow is to sit down with a business accountant and learn more about your current situation and projected future. A CPA can help you learn more about how your business is handling cash and help you find better ways to manage your cash flow; controlling this key element can help your business grow and succeed.
For help with your business accounting needs, call us at (301) 637-6453 for a consultation.