09 Nov Profit Versus Cash Flow, Which Should Be First?
There’s no question that cash flow is essential. It’s the lifeblood of your business.
But, it’s often a forgotten factor when starting a business.
Many companies I deal with in my turnaround practice focus on the income statement, but often the problem lies in the cash flow statement.
If you’re reading this article, you probably already know the main difference between profits and cash inflows.
In this blog post, I’ll explain the key difference between cash flow and profit and why keeping your eye on both is vital.
What is the Difference Between Profits and Cash Flow?
In simple terms, profits are the money left over after all costs have been accounted for, and on financial statements, it’s often called net income.
In other words, if you remove all business expenses such as cost of goods, salaries, operating expenses, taxes etc., profit is left on the income statement.
On the other hand, cash flow is about how much cash is coming into your business that is available to pay for things like salaries, advertising, and other operating costs.
Which Should be First? Profit or Cash Flow
I hope the answer is obvious.
The first task of the business owner is to ensure that there is enough cash in the bank account to run the business operations.
It’s essential to recognize that your sales revenue differs from cash in your bank account.
It is essential to understand your business dynamics to know your cash outflows vs cash inflows.
In addition, you have to understand what is happening in different ‘time period’ to avoid negative cash flow situations.
To highlight the importance of cash, one of my turnaround clients was growing total sales aggressively; however, it was a lot of credit sales.
The problem was who would cover the cash required for the sales.
They had to reach out to potential investors to cover the gap at harsh terms because the bank won’t help you when there is cash trouble.
At this point, I recommend you take a course in finance in case what I have said so far sounds alien.
However, you can click here and download my cash flow management guide to help you build a positive cash flow situation over time.
The guide will give you an approach to managing your cash balance and building the operating cash flow to run day-to-day operations and meet capital expenditures in long-term assets.
What About Profit?
If cash is first, profit is somewhere between first and second.
It’s essential to run a profitable business as this is the return on the capital invested.
When assessing a business’s financial health, I start with the financial metrics around cash and profit.
Just like cash, you have to keep an eye on your profit; there are three types of profit to measure and grow.
Gross profit margin indicates the percentage of total revenue left after taking out the cost of goods used to generate the revenue. It’s vital to keep this margin steady and seek opportunities to increase it.
Operating profit margin is the profit margin generated from your operations before paying taxes and interests. This margin tells you how well your operations is performing. In another way, is your business model working?
Net profit margin is what percentage of your total revenue the business keeps after the cost of production, operating expenses, taxes and financial costs. It is the amount of money available for dividend payments to business owners.
Remember, you can only make cash payments if you have cash in the bank. Large companies sometimes access bank loans to make dividend payments, a luxury not available to small business owners.
So What Next?
That’s a lot of information, so what should be done first? “Should I increase my profit margin or increase my cash flow?”
The reality is that both of these are equally important to long-term success.
In other words, if your profits are strong but your cash flow is low, you may go bankrupt in the long run.
If your cash flow is high but your profits are low, you will need more money to cover your expenses in the future.
Here are three steps you can take to move things forward in your business
1. Get Clear on where you are? Conduct a cash flow analysis and understand your margins.
2. Identify the key challenges and prioritize them. What needs to happen first? If in doubt, cash challenges first!
3. Create a plan to move your business into your ideal situation. Execute Execute Execute!!!
If you still need to, download my free cash flow guide.
In conclusion, cash and profit are essential to your business’s success.
If you want more help in your business, click here to book a complimentary breakthrough strategy session with me to generate options for your main business challenge.