If you run a business, you’re the first to know there’s a lot of numbers flying around. Turnover, profit, business costs and taxes all come with the territory and it can be hard to know how well your business is actually doing.
Whereas they’re all important, there’s one in particular you should keep your eye on. And, contrary to popular belief, it’s not your profit. It’s your cash flow.
Here’s why.
Your cash and profit are not one and the same.
The difference between cash and profit is an important distinction in business. Both are a big deal when it comes to your financial position. They each give different insights and should be reviewed together. but ultimately, cash will inform you and profit will sustain you.
Here’s exactly what “cash” and “profit” mean in this context.
Your profit is the cost of sales made, minus all costs and expenses of running your business. It measures the ongoing sustainability of your company and is the bottom line in your “Profit and Loss” sheet.
Your cash is the money the business has received for your services, minus the money spent, in the same time period. Your cash flow measures the company’s ability to pay its bills and keep afloat.
An example:
- Let’s say you run a recording studio, hiring out your space and equipment to local musicians. It’s the end of January. 50 customers turned up to use the space at £100 a session for that month.
- 20 of your customers have settled their bill so far, coming to £2000, which is in your business account.
- All of your business costs (like rent, bills, staff) amount to £1500 for January.
- Because your customers haven’t all yet paid, you have £500 left after settling your bills. This is your business’s cash
- Your sales came to £5000, minus all costs, that’s £3500. This is your business’s profit
When it comes down to it, cash is the money that’s physically in the bank once you’ve settled your costs. Profit is money, made from sales, that’s not necessarily in the bank yet.
Another key difference between cash and profit is that your profit can be impacted by non-cash items. Depreciation, for example, reduces your profit but won’t have any impact on what it says in your banking app. Unlike cash, which is final in its position, your profit can be affected by outside factors.
It’s near impossible to align your profit with your cash.
Your customers are humans with busy lives and different attitudes to how they settle debts. You will always have clients who pay before, during and after the pay period. That means when they pay is a variable factor, not a reliable one. Many businesses will make a sale and invoice their customers but won’t receive payment immediately.
Until they settle your invoice, there’s no cash in the bank but it will be recorded and counted as profit for that month.
If you keep referring to your profit, rather than what has actually been paid, you’re going to be way off in gauging your business’s financial position. Cash is the petrol in the car that keeps everything running. When the tank is empty, the car will come to a halt.
Some ways to boost cash.
When times are tight and you’re in tricky waters, profitability is all but useless in that moment. Cash flow, on the other hand, can be boosted by inputs other than sales and can restore some stability. You can look into:
- Capital injections by the owner/s or investors
- Selling an asset
- Trimming down expenses
- Rigorously chasing outstanding debts
- Taking out a loan
These sources will boost cash levels to help your business, but aren’t profitable. However, the fact you are profitable will be a contributing factor when it comes to obtaining cash injections and sustaining any repayment schemes.
Once you’ve “ridden the wave”, you can look into establishing proper cash reserves too. You can also implement a more effective invoicing structure for your customers. This eventually will mean your profit will more accurately align with the cash in your bank, although it will never be exactly the same.
A business’s success largely depends on cash flow, not profit.
Whether you’re a huge global corporation or a small independent store, it really comes down to the timing of money coming in and out. If you don’t thoroughly protect your cash position, any business will be at risk of closing, regardless of how profitable they are.
Real success looks like:
- Protecting your cash position. Know what it is and build a cash flow statement. Always keep it up-to-date. If you foresee a shortfall, start to fix it at once
- Creating a cash buffer. You can use this as an insurance against unexpected difficulties
- Maintaining a 3-6 month balance of operating expenses. This will protect your cash position against revenue shocks
- Being realistic with revenue expectations. Take immediate action if it looks like sales are not going to allow you to breakeven.
- Credit checking your customers. This will reduce the risk of customer non-payment. Make sure you follow up with clear payment terms agreed in writing. Communicate regularly and automate where possible.
- Creating a budget. Every pound you spend reduces cash reserves. The best way to protect your cash is to spend what you need, and stick to it!
These things will hugely ease the strain of tighter months and, going forward, a cash flow forecast will help predict them. When you closely document the inflow and outflow of payments you’ll learn how to best run your business. Even better, you’ll eventually be able to keep the cash where it belongs.
In the bank.
Now, we’re a dab hand when it comes to all things cash related (of course we are, we’re accountants!). If you know you want the data, the guidance and peace of mind in knowing you’re totally prepared, send us a note here.