Profit vs Cash Flow: What’s the Difference?
Profit vs Cash Flow Operations
Most times, when we talk with a business about the taxes they owe on their profits, the most common question asked is, “If my business is profitable why don’t I have any money?” The way cash flows in and out of your business is a lynchpin for understanding corporate finances.
There is also a huge difference between making money and managing it. Often, entrepreneurs start a business because they love creating a new widget, or offering a leading-edge service, but they have little to no business management experience. Terms like forecasting, budgeting and cash flow are meaningless until the monthly bills pile up and payroll can’t be covered. Rather than waiting until there’s a problem, let’s make a promise to learn the basics about how profits and cash flow operate.
The Difference Between Profits and Cash Flow
Profit is the difference between the amount earned and the amount spent in buying, operating, or producing something. This means any money left over after all the bills are paid is considered profit. Conversely, cash flow refers to the total amount of money being transferred into and out of a business, i.e. where the money is going and why. If you go to the store to buy milk and you have no money, you have a cash flow problem.
If you have money expecting to arrive in two months, that makes buying milk nearly impossible now even though profitability is promised at a later date. The other bottom line is that a business selling additional widgets (i.e. increasing sales) does not necessarily mean an immediately increase in cash flow. In fact, more often than not, the increased sales will immediately reduce it. Now you’re thinking, if sales help to generate revenue, why wouldn’t I want more sales? Sales, especially where widgets are concerned, will require an immediate additional cash outlay to manufacture, package, and distribute the item(s). All of these steps must occur well in advance of delivery and invoicing and another ten to 45 days or more can go by before the company is paid for the products or services. That timeframe between production of the widget and payment of the widget is where cash flow management lives.
Look At Your Options
Precise cash flow management, much like a synchronized swimming routine, must occur in a timely, well-choreographed manner in order to keep the business operating, expenses covered, and employees paid. Part of this monetary routine can include:
Collections - Where are your current account receivables? Are they current or in arrears and if so, how far? By placing your attention on existing receivables and making efforts to encourage payments, cash flow will be improved. For invoices that are more than 90 days past due, consider a collection agency or some other type of arrangement to get paid in an appropriate timeframe.
Delaying Cash Payments - Review how your orders are placed for materials with vendors. Can you set contracts for orders where a percentage is paid up front and the remaining balance paid in 15 to 30 days? This will improve cash flow as it will remain in-house longer.
Raising Additional Capital - If you cannot meet your financial obligations within the necessary time, it may be in your best interest to solicit additional cash through loans, issuing capital stock, employee ownership or some other type of arrangement. Again, planning and attention to cash flow can help with strategic timing, more attractive interest rates and loan agreements. Covering debt in a crisis will inevitably mean less attractive interest payments and possibly selling more ownership than originally intended.
Too Much Competition Can Kill Revenue
That’s right, the one thing that makes capitalism work is competition, yet competition can be the very thing that can take a business down under.
How? When businesses are constantly bidding and trying to shave off profit margins in order to win the contract, those pennies, nickels and dollars can all add up to no actual profit at the end of the day. Yes, the business has lots of money moving through the business, but not much staying in the bank accounts. Try to be brutally honest with yourself and your bidding so that you know up-front if your business can afford to take a reduction in costs or even a loss in order to gain business. Make sure that you are working with real-time numbers and partner with your finance team to plan for losses on one contract and profits on another. There are volumes of books and doctoral theses on the process of cash flow and cash management which can be consulted. If you don’t have that kind of time, the right move might be to bring in some additional financial advisory assistance.
