What’s the Difference Between Small Business Profits and Cash Flow?

Author: Caron Beesley | March 25, 2015

If your business is successful – i.e. you’re selling goods and services at or above your forecasted rate – yet you’re still feeling a financial pinch, you may be experiencing cash flow problems.

Cash flow or rather a lack of it is one of the main reasons that small businesses fail. Too often, businesses focus on overall profitability as a metric in their planning and review exercises.

This is the first stumbling block! Your profit and loss (P&L) statements won’t tell you anything about your cash flow situation. That’s because your bottom line profitability (what is left from your sales revenue, after all, your expenses have been paid) only takes into consideration your income and expenses at a certain point in time. Cash flow, however, is fluid, harder to predict, and can change from month-to-month depending on circumstances.

Cash flow is king
Cash flow, therefore, not profit is a truer reflection of the financial health of your business. You can be profitable and yet still face a cash crisis – one does not mirror the other.

For example, if your expenses exceed your income at a particular point in time, whether it’s due to late paying clients (even if the profit margins on those sales were strong), unexpected outgoings or credit-based sales, then you have a cash flow problem. Likewise, large purchases can make a huge dent in your cash situation but will have no impact on profits.

On the flip side, small businesses can be in a cash flow positive situation, but not be profitable. For example, if you’ve benefited from an injection of cash but spend more money than you are making, your profit will be negative – a common scenario among start-ups who have yet to break-even.

When it comes to getting your finances in order and growing a successful business, profitability is clearly the long-term goal unless you’re fortunate enough to find investors who’ll continually make up for your losses. But on a month-to-month basis, cash flow will always be king – you have to be able to pay your bills, and that’s what ultimately keeps you in business.

How do you convert profit into a cash flow positive situation?
With proper planning, cash can be managed as diligently as your profits. This is where your business financial statements come into play – to succeed you need to wrap your arms around your data.

This starts as early as the start-up phase, sure you have a business plan, but you’ll also need a break-even analysis. This will tell you when you can expect to cover all your expenses and make a profit.

Next up is the cash flow statement. By maintaining a monthly cash flow statement, you’ll learn how funds are flowing in and out of your business and whether you have sufficient cash to cover your costs and grow your business. Most business accounting software such as QuickBooks, Xero or FreshBooks have cash flow statement tools. You can also use a simple spreadsheet – but make sure to update it on a regular basis to ensure your checking account balance is positive – i.e. you’re earning more than you’re spending.

It’s also important to maintain a cash flow forecast so that you can anticipate your cash flow situation for the next 12 months. Your forecast will help you prepare for seasonal fluctuations such as peak inventory purchasing periods or costs associated with a big sales or marketing push and give you time to plan your capital needs accordingly. Check out this free sample cash flow projection spreadsheet from SCORE (scroll down and select “Cash Flow Statement (12 Months)”.

Calculating the profitability of your business is done using a profit and loss (P&L) statement. This provides a big picture view of your business expenses (losses) and revenue generated over time.

Tip: It’s critical that you maintain both a cash flow statement and a P&L statement because cash and profitability are two separate indicators. If your business shows a profit but maintains a weak cash position, these two statements will give an insight as to why.

The last financial statement you’ll need is a balance sheet. This is a snapshot of what your business owns (its assets) and what it owes (liabilities). The balance sheet won’t inform you cash flow or profitability, however it is the leading indicator of the overall stability and liquidity of your business and is a useful tool for determining your ability to fund your growth.

The Bottom Line
It doesn’t matter how profitable your product or service lines are, if you can’t pay your bills on time you’re in trouble. Maintaining key financial statements will help you understand how and when cash is flowing out and into your business. Accounting software with its dashboard insights can really help with this, be sure to choose one that your accountant is familiar with so that you can share your books more easily and benefit from his or her insight too.

There are also some general business management practices that you can take to ensure your business is both profitable and cash flow positive, such as shifting dead inventory, expediting accounts receivables, and more. Read more in our earlier blog: 5 Ways to Get More Cash Flow Out of Your Business.

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