Cashflow Vs Profit

Have you ever wondered why you haven’t got the profit your Accountant has told you you earned, and you pay tax on, in the bank?

The purpose of a business is to make money.  In order to ensure it does you need to have a clear understanding of the difference between profit and cashflow, as not recognising the difference between these two is one of the biggest mistakes a business owner can make.

Net profit is what remains after you deduct all the expenses you incur running your business from the revenue you generate from sales to your customers.

It is critically important to understand that net profit is “what’s left over.”  You can’t do anything about net profit.  All you can do as the manager of your business is influence those things or activities which ultimately affect revenues and expenses.

For example, you can train your team members so that they are more efficient in dealing with your customers, which in turn will mean your customers will buy more from you.

You can also implement a system to find out from your customers what aspects of your business are important to them so that you can better meet their needs.  This will mean they come back to you more often and they will refer you to their friends and associates.

You can negotiate better trading relationships with your suppliers, which in turn may result in less inventory being carried or better buying prices.

Cash flow is the cash that flows into a business from various sources, such as sales, receivables paying their account, additional borrowings or capital introduced, the disposal of equipment, etc.  On the other hand, cash also flows out of the business to pay for operating expenses, taxes, the purchase of equipment, the repayment of loans, distributions to the owners, and so on.

It is important to understand the essential difference between profit and cash flow.  A business that is profitable will not necessarily have a good cash flow.  Similarly, a business with good cash flow may not necessarily be profitable.  For example, you could sell off an asset, which provides you with cash, but it may detrimentally affect your profitability.

It is almost always the case that a business experiencing rapid growth is starved for cash.  Whereas, a long-established, mature business, which experiences only modest growth, is usually an excellent cash generator.

The fundamental issues which determine how quickly a business can grow are:

  1. The magnitude of its net profit and hence, market demand and cost structure
  1. The willingness of the owners of the business to reinvest after tax profit to finance the additional resources
  1. The availability of debt finance, which depends on the capacity of the business to service the debt, and the security that can be offered to lenders

Business owners often believe banks have an obligation to lend them unlimited amounts of money simply because they have excellent profit potential.  In fact, the reluctance of banks to make unlimited funds available in many cases is a blessing in disguise.  Unfortunately, this reluctance also means that some extremely well-managed businesses, which have  excellent potential, are denied access to much needed funds.

To determine how fast you can grow your business, you need to look at your projected cash flow

You can’t grow a business faster than your cash flow will allow.

For more information on this topic and financial management for businesses be sure to join us at our Advanced Financial Management Programme.

 

 

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